Ways to Make Tax Compliance Less of a Nightmare for Small Business

As Tax Day approaches, the question of time and money spent to comply with the U.S. tax code, particularly for small businesses, is a popular topic, with an unpopular response. Compliance costs for an employer with 1–5 employees range from $4,308 to $4,276 per employee, according to the chairman of the House Subcommittee on Economic Growth, Tax and Capital Access, Rep. Tim Huelskamp, R-Kan.

But, in the absence of major tax reform, some solutions do exist, experts told the subcommittee at an April 13 hearing. One important step for simplifying small business taxes is eliminating the complicated web of state laws for withholding taxes on nonresident employees, said Troy K. Lewis, CPA, chair of the AICPA’s Tax Executive Committee.

“As CPAs, we see, firsthand, small businesses on Main Street and their employees getting caught up in this web of inconsistent state income tax and withholding rules,” he said. One state may exempt a nonresident who works in the state for 15 days from income tax withholding, while another exempts nonresidents who work for 59 days. To point out how difficult compliance can be under this web, Lewis used an example of a real estate developer whose employee visits 20 prospective sites in 20 different states and spends less than a day in each state and who could be subject to state tax withholding in each of those states.

Unfortunately, he noted, the existing reciprocity collaboration between some states that border each other provides only patchwork relief, with two-thirds of the country not covered by such agreements. Agreements that do exist are “primarily geared toward nonresident employees who ordinarily commute a few miles a day to adjoining states.”

Lewis urged lawmakers to pass legislation that would provide overdue relief for this problem as soon as possible, noting that the Mobile Workforce State Income Tax Simplification Act of 2015, H.R. 2315, would have minimal financial impact on states. According to the revenue estimate for the bill, 18 states would, in fact, gain revenue. The bill would prohibit states from taxing most nonresident employees unless the employee is present in the state and performing employment duties for more than 30 days during the calendar year.

Rep. Mike Bishop, R-Mich., co-sponsor of the bill, echoed Lewis’s description of the complexity that is bewildering to employers and taxpayers. “It really is absurd,” he commented, observing that an employer may have to file as many as 50 Forms W-2 for one employee.

Lewis described the bill’s 30-day threshold as a reasonable balance between states’ rights to tax income from work within their borders and taxpayers’ and employers’ needs to operate efficiently. “Let’s keep it simple,” Lewis concluded.

Other panelists echoed that theme. Offshore reporting requirements have “become a game of ‘gotcha’ for businesses operating overseas,” stated Robert M. Russell, an attorney with the Alliantgroup, a tax consulting firm. He urged the panel to reexamine those laws and told the panel that compliance costs skyrocket for businesses overseas. In addition, Russell said that U.S. laws and the tax code actually cost U.S. companies business as some foreign businesses do not want to deal with the complexity.

Altering the laws so that small businesses can better take advantage of tax benefits would make the system fairer as well, contended Mel Schwarz, a partner with Grant Thornton LLP (but speaking for himself). “Small businesses feel that they have been left out.” For example, claiming employee wages as part of the research credit is challenging because regulations require 80% of the person’s time be spent on qualified research activities, but small business employees are likely to have broader responsibilities. A 50% threshold would provide the type of cushion they need, Schwarz said. Similarly, the 95% safe harbor for domestic production gross receipts under the Sec. 199 domestic production activities deduction could be changed in several ways to be more beneficial to smaller businesses.

The overall message from the panel was a plea for less paperwork and hassle. Asked by the chairman what would be the most important change if he could wave a magic wand, Lewis responded that it would be lowering the administrative burden of compliance.

Julie Verratti, a founder of Maryland-based Denizens Brewing, agreed, and called for streamlining federal and state reporting requirements. Verratti estimated she spends 11 hours a month on taxes and “much of it is duplicating information from one report to another.” Providing instructions in plain English would also help, she said. Even with a law degree, Verratti said she sometimes “has no idea what they [government agencies] are asking me to do.”

—Ann Marie Maloney (amaloney@aicpa.org) is an AICPA tax communications manager.