Virginia: Payroll Reports Do Not Always Clearly Show Payroll Factor for Apportionment

Many companies typically rely on payroll reports as support for wages paid by state to calculate the payroll factor, but a recent Virginia ruling request highlights the discrepancies that can occur.

By Tina Chunn, SALT senior manager

As companies gather their apportionment data each year, many typically rely on payroll reports as support for wages paid by state to calculate the payroll factor. However, Virginia recently issued a tax ruling which highlights the discrepancies that can occur in using this documentation for these purposes. [1]

This ruling request was in response to an assessment by the Department which increased the numerator of the reported payroll factor to include employees’ wages as reported to the Virginia Employment Commission. Specifically, this change caused the inclusion of wages attributable to employees working exclusively overseas. The taxpayer argued that these wages should have been excluded from the numerator of the payroll factor for Virginia apportionment purposes, as these employees were not working from within state of Virginia. The Department’s position is that these employees were reported as Virginia employees and should therefore be included in the payroll factor.

In this case, the taxpayer had originally reported the income tax withholding wages for purposes of the payroll factor in Virginia. Upon audit, the Department adjusted this amount to reflect the wages as reported to the Virginia Employment Commission for unemployment purposes. This adjusted amount was higher due to the inclusion of employees working solely overseas as Virginia employees since it was not practical to determine the true state of residence for each employee. However, by identifying these employees as Virginia employees for unemployment purposes, the taxpayer would now have a burden of proof to support their omission from the numerator of the payroll factor. [2]

This ruling identifies two common mistakes made by taxpayers when calculating payroll for apportionment purposes. First, it is standard practice for most companies to utilize state income tax withholding data as shown on their payroll reports with minimal analysis of the employees included for each state. However, the rules governing the calculation of the payroll factor do not generally support the use of this report in most states. Rather, the payroll factor calculation is typically based on where the employee actually performs services, and this rule may, in some cases, more closely relate to the calculation of wages for unemployment purposes. [3] Second, employee wages are not always carefully reviewed in connection with the employee’s service activity to identify any discrepancies that would cause the wages to be excluded from reporting for unemployment purposes.

It should be noted that there may still be some discrepancies between the wages reported for payroll factor apportionment calculations and unemployment purposes. Many states have specifically identified certain wages that are subject to one but may be excluded from the other. For example, some states exclude officer compensation from the payroll factor. These differences will typically be the items to consider when calculating your payroll factor for apportionment.

HA&W’s SALT team is able to provide clarity and guidance in making determinations for tax areas such as this and can assist in any analysis that may be necessary. We constantly strive to keep our clients advised of these important issues and problem areas in order to help them address their specific tax situations. We will continue to monitor and report these and other significant income tax developments in future issues of the HA&W SALT Newsletter.

Contact Tina Chunn, SALT senior manager, at [email protected] or Jeff Glickman, partner-in-charge of HA&W’s SALT practice, at [email protected] for more information.

[1] Ruling of Commissioner, P.D. 15-166, Virginia Department of Taxation, Aug. 18, 2015.

[2] The Virginia rules for sourcing payroll for apportionment purposes are nearly identical to the rules for reporting Virginia wages to the Virginia Employment Commission for unemployment purposes. Therefore, there is a strong presumption that those amounts should be equal. See Ruling of Commissioner P.D. 02-127, Virginia Department of Taxation, Oct. 6, 2002.

[3] Here is a simple example: An employee is a resident of state A but travels to work each day and performs employment services in state B. State B does not impose a personal income tax. In this case, the employer may withhold state A income taxes from the employee. However, since all of the employee services are performed in state B, the employee’s wages would be reported in the numerator of state B’s payroll factor, not state A’s. If payroll withholding reports are used, then the employer will overstate state A’s payroll factor and understate state B’s.

This article was featured in the
October 2015 SALT Newsletter.

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