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Seattle Payroll Expense Tax – New Rule and Guidance Issued

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The City of Seattle has finalized their rule on the new payroll expense tax which became effective January 1, 2021.  We previously issued a blast on this ordinance, with details on how this tax applies to businesses.  The rules clarify several areas of uncertainty in how the ordinance will be implemented.

Notable in the rule are several definitions as well as examples of how the tax calculations work in various scenarios.   For example, in addition to wages and bonuses, taxable compensation includes items such as stock grants, certain benefits and guaranteed payments paid to partners for work performed for the business.  The rule also provides some additional clarity on when compensation is sourced to Seattle to calculate the payroll expense threshold and ultimately the tax calculation.

To determine whether an individual’s compensation is sourced to Seattle, three tests are applied (satisfying any test results in Seattle sourced compensation).  These are the same tests as used for the payroll factor of the local apportionment calculation and consider where an employee is primarily assigned, where they predominantly perform their services and where they reside (a decision tree is included in the rule).  For employees that perform 50% or more of their services at a business location of their employer, this will be the location where their wages are sourced.  There are several examples covering scenarios where employees work remotely.

Another complexity of the tax is which individuals the business must include in their calculations to determine if they meet the $7 million payroll threshold or have “employees” earning over $150,000 in the city.  Employees are defined to include traditional employees as well as owners of pass-through entities and independent contractors working for the business.  However, independent contractors whose compensation is included in another business’ payroll expense are excluded from the calculations of the business for which they perform services.

The examples appear to draw a distinction between sole-proprietor independent contractors (who would be considered an employee of the business for which they perform services) vs independent contractors who are performing the services as employees of another businesses.  In the latter case, since they are employees of another business, they would not be included in the payroll calculations of the businesses for which they are performing services (as they are included in the payroll expense calculations of their employer).  Businesses utilizing staffing or placement agencies or gig workers should review the rule’s impact on their businesses.

Top five takeaways from the final tax rules

  • Employees are defined broader than W-2 employees and may include pass-thru entity owners and independent contractors
  • Due to the sourcing rules, businesses with no Seattle office location may have Seattle sourced compensation if they have employees who work 50% of more of the year in Seattle or reside in Seattle.
  • The tax applies to businesses with Seattle sourced payroll of $7 million or more in the prior year AND have individuals with compensation of $150,000 or more in the current year.
  • The first filing and payment due date is January 31, 2022 for the 2021 calendar year. Subsequent years will require quarterly filing.  These returns will be available through FileLocal later in the year.
  • Businesses are responsible for creating and maintaining adequate records to substantiate the tax due. While this will include tax and payroll records, additional documentation will need to be created and maintained to substantiate where workers physically perform their services as well as any remote working agreements.

Seattle Payroll Tax Expense information and rule: https://www.seattle.gov/license-and-tax-administration/business-license-tax/other-seattle-taxes/payroll-expense-tax