The Nebraska Department of Revenue issued draft guidelines explaining when payments to nonemployees who are nonresidents are subject to income tax withholding. The Department has also published new Form W-4NB, Nonresident Individuals Performing Personal Services in Nebraska, to document circumstances when it is not necessary to withhold state income tax. (Guidance information letter 21-18-1, February 7, 2018.)

State income tax law is unclear

Under Nebraska income tax law (Neb. Rev. Stat. Section 77-2753(2)), state income tax must be withheld from a payment to a nonresident/nonemployee of Nebraska if the payee is not an employee; the payment is not subject to federal income tax withholding; and the payer is either (1) maintaining an office or transacting business within Nebraska and making a payment or payments of more than $600, or (2) making a payment or payments in excess of $5,000.

Existing Form W-4NA, Nebraska Income Tax Withholding Certificate for Nonresident Individuals, must be completed when withholding is required from payments to a nonresident.

When must Form W-4NA be completed?

Form W-4NA is used to compute Nebraska income tax withheld from payments to nonresidents for personal services in Nebraska. Personal services include, but are not limited to: payments to nonresident entertainers; individual athletes; performers; consultants; public speakers; corporate board directors; or other professional services.

Cooperation between the payer and payee is necessary to complete Form W-4NA. The income tax withholding is reported to the person performing the personal services and the Department in the same manner as wages or other payments subject to income tax withholding (using federal Form 1099-MISC and state Forms 941N and W-3N). The Forms 1099-MISC or 1042-S state copies must be included with the Form W -3N, Nebraska Reconciliation of Income Tax Withheld.

A payer or withholding agent who pays a nonresident alien individual for providing personal services and who has withheld federal income tax reported on Federal Form 1042-S, Foreign Person's U.S. Source Income Subject to Withholding, must also withhold state income tax using Nebraska Form W-4NA. A nonresident alien whose country has a tax treaty with the U.S. may not be subject to nonresident income tax withholding. The payer must obtain a written statement from the payee certifying the existence of a treaty exempting U.S. income earned by the alien from federal or state income tax.

Payments to a corporation are subject to the income tax withholding requirements if 80% or more of the voting stock of the corporation is held by the shareholders who are performing personal services. Payments to a partnership or LLC are subject to the income tax withholding requirements if 80% or more of the capital interest or profits interest of the partnership or LLC is held by the partners or members who are performing personal services. All payments and withholding are deemed to be made to the individuals performing the personal services. (Form 1099-MISC should be issued only to an individual, not an entity.)

A penalty may be imposed, in addition to other penalties provided by law, on a nonresident individual for giving false information to a payer regarding payments subject to income tax withholding, if the information could result in the amount of income tax withheld totaling less than 75% of the income tax liability on these payments. A penalty may also be imposed on any payer who either knowingly uses false information or who maintains records which show the information is false. The penalties may equal: (a) the amount of tax evaded, not collected, or not accounted for and paid over; and (b) an additional amount up to $1,000.

Proposal further explains when withholding for nonemployees is required

According to the Department, guidance has been requested by several taxpayers about what level of presence in Nebraska is necessary to determine if personal services are "substantially in Nebraska" and thus require the withholding of income tax from payments in excess of $600 to a nonresident nonemployee.

According to the state, the issue happens frequently when nonresident individuals enter Nebraska one or more times to conduct onsite testing, research, consultation, or other activities; and also spend much of their time outside Nebraska at the home office, for example, performing important activities such as analyzing data, consulting with other professional colleagues, or writing a report.

The Department agrees that the law is unclear because it does not define what is considered to be services performed "substantially in Nebraska." As a result, the Department proposes that the term "substantially in Nebraska" be defined as the "considerable" and "essential" performance of duties.

To be "considerable," the services must be performed more in Nebraska than in any other state. The service provider does not have to spend a majority of the time in Nebraska, as long as the time spent in Nebraska is more than the time spent in any other state.

To be "essential," the actions taking place in Nebraska must be performed in Nebraska to complete the services. If the services cannot be performed competently without performing certain activities in Nebraska that are more than de minimis, the services are considered to be performed substantially in Nebraska.

If the services performed may be considered neither (a) considerable nor (b) essential, the involved parties may execute draft Form W-4NB, Nonresident Individuals Performing Personal Services in Nebraska, to document why it is not necessary to withhold state income tax.

The draft form will not supersede existing Form W-4NA, which must be completed when nonresident personal services withholding is required.

Summary

In summary, the requirement to withhold income tax from payments in excess of $600 does not apply (and the parties should execute Form W-4NB) when the agreement between the payer and the nonresident individual makes it clear that:

(a) the most hours worked in any single state are worked in a state other than Nebraska; or
(b) no essential activities are being performed in Nebraska.

If the circumstances of the nonresident's service change substantially, it should be reassessed whether a Form W-4NB continues to reflect the understanding of the parties and whether the withholding requirement should then apply. Failure to reassess the situation will not relieve the payer from liability when the facts and circumstances change. If the payer accepts or reassesses an acceptance of a Form W-4 NB in good faith, the payer will not be liable for withholding with respect to the personal services that are provided by the nonresident individual.

The guidance notes, however, that whether or not income tax withholding is required by law, nonresident individuals with Nebraska source income are required to file a Nebraska Individual Income Tax Return, Form 1040N, and the accompanying Nebraska Schedule III.

Comments requested on the draft guidance

The Department is requesting comments be submitted on the draft guidance and Form W-4NB by March 7, 2018 to dawn.holtmeier@nebraska.gov. After any comments are reviewed, the guidance and form will be finalized later this spring.

Note, however, payers are allowed to use draft Form W-4NB, when applicable, during the comment and review period.

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