The document discusses the rise in New York State employer withholding tax examinations. It notes that New York continues to be a center for finance, innovation, and multinational headquarters, bringing increased business travel and scrutiny for taxpayers. The article outlines some key focus areas of the NY tax department's audits, including withholding taxes for nonresident employee wages, trailing compensation like stock options, work assignments, and ensuring accurate withholding tables are used. Employers are advised to closely track employee travel, maintain documentation of withholding policies and decisions, and understand the complex rules around different types of compensation to avoid compliance issues in these rising audits.

1. Reproduced with permission from Tax Management Weekly State Tax Report, WSTR 05/13/16, 05/13/2016.
Copyright ஽ 2016 by The Bureau of National Affairs, Inc. (800-372-1033) http://www.bna.com
Ta x P o l i c y
New York State continues to be the global center for finance, innovation and multina-
tional corporate headquarters, but that can come with increased scrutiny for taxpayers. In
this article, Ernst & Young’s Richard Ferrari, Peter Berard and Francis Cannataro discuss
the rise in state withholding tax audits.
New York State Employer Withholding
Tax Examinations Are On the Rise
BY RICHARD FERRARI, PETER BERARD AND FRANCIS
CANNATARO
N
ew York State (NYS) continues to serve as a
global capital for finance, innovation and multina-
tional corporate headquarters. As such, business
travel continues to rise, and NYS is the beneficiary of
many executives visiting for business purposes. It has
also become the leading state in the country in pursu-
ing withholding tax audit examinations, holding em-
ployers responsible to withhold, at source, income taxes
on earnings associated with services performed while in
NYS.
As a result, Ernst & Young LLP (EY) has seen a sig-
nificant increase over the past three years in both busi-
ness travel and nonresident income tax enforcement in
NYS. Evidencing this trend is the state’s publication of
withholding tax audit guidelines intended to streamline
and standardize the audit examination process for its
employment tax auditors. These guidelines are lengthy
and specific, and they provide detailed instructions for
various procedural aspects layered into audit examina-
tions.
In particular, we have recently observed a height-
ened focus by the New York State Department of Taxa-
tion and Finance (NYSDTF or the department) on the
financial services sector as well as other key industries.
Despite the frequency at which the NYSDTF initiates
examinations and the volume of current audits, there is
no indication that the department has turned its atten-
tion away from pursuing other businesses that are cur-
Richard Ferrari is an indirect tax partner for
financial services , Peter Berard is a senior
manager with employment tax advisory ser-
vices, and Francis Cannataro is staff with
employment tax advisory services in Ernst &
Young’s New York City office.
Copyright ஽ 2016 TAX MANAGEMENT INC., a subsidiary of The Bureau of National Affairs, Inc. ISSN 1534-1550
Tax Management
Weekly State Tax Report™

2. rently free from scrutiny. In addition, we have noticed
that employers who were previously under examination
are just as susceptible to renewed audit attention as
other previously audit-free businesses. Considering the
dollars at stake, there is little to suggest that the
NYSDTF will soften its strict approach, and the current
audit cycle trend will likely continue into the foresee-
able future.1
Employers are no longer asking whether they should
comply with NYS withholding tax rules. Instead, busi-
nesses are seeking support to overcome significant
challenges associated with bringing their internal poli-
cies into compliance with NYS’s complex tax regime.
Background
The withholding tax audit process relies on the me-
chanical operation of New York tax law, regulations,
technical documents,2
audit guidelines and historical
audit precedence. In particular, it focuses on an em-
ployer’s obligation to withhold NYS tax owed by its em-
ployees.
Generally, NYS tax law requires employers main-
taining an office or transacting business within NYS to
deduct and withhold NYS personal income tax from
taxable wages paid to a resident or nonresident indi-
vidual.3
Specifically, employers must withhold NYS in-
come tax from all wages paid to NYS residents, regard-
less of where services are performed. However, for non-
residents, only wages paid for services performed
within NYS are subject to withholding tax. In this con-
text, wages are payments typically considered wages
for federal income tax withholding purposes.4
As a re-
sult, an employer must withhold tax on a broad spec-
trum of compensation, including regular wages, trailing
compensation (e.g., stock options, restricted stock or
deferred compensation), bonuses and severance pay-
ments.
Although nonresidents are typically only taxed on
wages earned from services performed within NYS, ex-
ceptions exist. NYS is one of only a handful of states in
the country to incorporate a ‘‘convenience of the em-
ployer’’ test into its withholding tax architecture.5
This
‘‘telecommuter rule’’ generally requires that any non-
resident individual assigned to a primary work location
within NYS must have 100 percent of wages sourced to
NYS if the services rendered outside of NYS were for
the employee’s convenience and not for the necessity of
the employer, and the employee performs some amount
of services within NYS during the year at issue. The
rule does contemplate an exception for work performed
at a bona fide employer’s office, but satisfaction of the
requirements needed for a bona fide employer office to
exist occurs only in the narrowest of circumstances.
Consequently, the reach of NYS withholding tax law
extends further than what most employers perceive it to
be.
Primarily, business travelers remain the key focus of
the NYSDTF. The majority of employment tax non-
compliance issues arise from the complexity associated
with withholding, remitting and reporting the correct
amount of tax from wages paid to nonresident employ-
ees who are not assigned to a NYS office. The rigidity
of some modern payroll systems underscores this diffi-
culty, as many employers are simply unable to track
multistate travel or withhold tax from wages and report
such withholding to multiple states.
NYS Withholding Tax
Examination Process
A typical withholding tax audit begins with the
NYSDTF sending an employer a formal audit notifica-
tion letter that identifies tax periods under scrutiny and
specifies information required for the auditor to con-
duct the examination. Included in the information re-
quest is generally a demand to review books and re-
cords, a power of attorney form,6
and a questionnaire
tailored to identify an employer’s landscape, develop an
audit plan, and spot potential gaps in an employer’s
withholding process, controls and compliance.
As part of its information request, the NYSDTF will
require an employer to provide an electronic file sum-
marizing all domestic wages paid to employees across
all U.S. states and taxes withheld for the calendar
year(s) under examination. The NYSDTF also seeks
key elements of information such as business traveler
policies and travel expense reimbursement records.
These requests may appear overly broad to an em-
ployer, but are essential to the NYSDTF in achieving its
aim of accurately determining the identity and fre-
quency of employees traveling to NYS throughout the
period in question.
During examinations, the department looks to spe-
cific key areas where an employer may be non-
compliant. Audit guidelines prescribe approximately 20
different tests, or ‘‘reports,’’ relating to separate areas
of potential compliance issues.
For instance, Report 7 relates to all employees with a
NYS zip code, address or resident state code and zero
NYS withholding. If applicable, the existence of such
employees could indicate that the employer paid wages
to individuals on which withholding was required but
no withholding occurred. Additionally, Report 20-2 per-
tains to Form 1099-MISC recipients who were not em-
ployees in the current year but were classified by the
employer as employees in at least one of the prior five
years. Such data assists the auditors in their review of
whether workers were properly classified as indepen-
dent contractors.
As shown in these examples, each report is narrowly
focused, but in the aggregate they serve the NYSDTF’s
broader purpose—namely, an analysis of whether an
1
NYS generates tens of millions a year in revenue via with-
holding tax audit examinations alone.
2
The department issues a range of informational guidance,
including advisory opinions, technical memoranda and tax
bulletins. While accurate on the date on which a publication is
issued, any subsequent change in the law, regulations, judicial
decisions or changes in department policies could affect the
validity of the information presented in such guidance.
3
N.Y. Tax Law §675.
4
20 N.Y.C.R.R. §171.3(a)(1); IRC §3401(a).
5
20 N.Y.C.R.R. §132.18; Technical Memorandum TSB-M-
06(5)I; Huckaby v. New York State Division of Tax Appeals,
2005 N.Y. LEXIS 497 (2005); Zelinsky v. Tax Appeals Tribunal,
1 N.Y.3d 85, 801 N.E.2d 840, 769 N.Y.S.2d 464 (2003).
6
Due to extensive audit procedures and potential conse-
quences of a negative audit assessment, the NYSDTF provides
the employer with a power of attorney form so the taxpayer
can appoint a qualified representative to discuss the case.
2
5-13-16 Copyright ஽ 2016 TAX MANAGEMENT INC., a subsidiary of The Bureau of National Affairs, Inc. TM-WSTR ISSN 1534-1550

3. employer is compliant in specific key areas. The follow-
ing represents areas of attention featured prominently
during an examination.
Multistate Nonresident Withholding for Regular Wages.
Typically, employers based outside of NYS are unaware
that they may have an income tax withholding obliga-
tion. However, as mentioned earlier, NYS mandates
that employers must withhold tax from nonresident em-
ployees who earn NYS source wages.7
This mandate means employers are responsible for
accurately monitoring when employees travel to NYS
and how much tax to withhold from a nonresident’s
wages. As a result, businesses employing individuals
who travel frequently are at risk. This is especially rel-
evant in high-paying industries. A significant tax liabil-
ity can accumulate quickly, even without the employee
spending significant time in the state.
Many employers and practitioners are familiar with
the NYS 14-day de minimis withholding threshold,
which states that, if a nonresident employee is not rea-
sonably expected to surpass 14 days of service in NYS
in a given calendar year, then the employer is not re-
quired to withhold NYS taxes. While the department
will not penalize an employer for failing to withhold tax
on wages during these first 14 days based on a reason-
able expectation, the obligation to report an employee’s
wages in Box 16 of Form W-2 still exists for the em-
ployer. Additionally, depending on the amount of in-
come attributable to New York for a nonresident em-
ployer, an individual income tax return reporting obli-
gation may still exist. Further complicating the rule,
withholding relief is not available to employers who ex-
pect the traveling employee to work in NYS for more
than 14 days in a calendar year.8
The NYSDTF understands this reality and puts sub-
stantial effort focusing on whether an employer allo-
cated and withheld the appropriate tax on the wages of
its nonresident employees. This necessarily includes
withholding correctly on compensation not considered
regular wages because employers cannot avail them-
selves of the 14-day rule’s protection when paying trail-
ing compensation to its employees.
Trailing Compensation. Payments to employees of
stock options, deferred compensation, and other in-
come earned in a prior year and paid in a later year are
subject to considerable scrutiny by audit examiners.
Not only can wages resulting from the exercise of trail-
ing compensation be material (and in some cases may
reach tens of millions of dollars), but rules governing its
taxability are more complicated.
Employers are obligated to withhold tax on the por-
tion of trailing compensation which is considered NYS
source income. The method by which this tax is calcu-
lated for NYS nonresidents is similar in some respects
to wages subject to nonresident withholding. However,
the time frame an employer must use to allocate the in-
come is distinct. No longer is it simply time spent in
NYS within a single year, but rather, an employer must
calculate the total time an employee performed services
in NYS during the period in which the trailing compen-
sation was earned. In such circumstances, the compen-
sable period may extend to more than 10 years.
Moreover, the 14-day exception to withholding does
not apply. An employer is obligated to withhold from
the first day trailing compensation is earned in NYS.9
The resulting demands on the employer to comply
with the law and related rules are thus great. Employee
work location and travel must be tracked with records
preserved. Employers must also understand the nu-
ances between various trailing compensation payments
(e.g., restricted stock units, restricted stock awards and
non-statutory stock options). NYS delineates rules for
each type of equity payment and the time period in
which the compensation is considered earned (i.e., the
allocation period). Therefore, an employer must comply
independently with each rule governing a specific com-
pensation type and cannot assume that each type is
taxed in the same manner
Furthermore, an employer must still withhold NYS
tax on trailing compensation earned in NYS regardless
of whether the employee moved out of the state in a
prior year or no longer works in the state during the
year in which the taxable event occurred. NYS with-
holding tax is owed on all trailing compensation earned
in NYS without concern to the employee’s work loca-
tion or residence in the year in which it is paid.
Consequently, non-compliance issues related to
these types of compensation frequently occur. Employ-
ers may be unaware or unprepared to comply with
these requirements and, as a result, are left vulnerable
to substantial consequences, especially from a vigilant
NYSDTF.
Work Assignments. Employers must also be cognizant
that the NYSDTF focuses on whether tax is properly
withheld for employees that come into or leave the state
due to a work assignment. Typically, employees per-
forming services within NYS on assignment are identi-
fied by auditors by the address of the employee and
from a discrepancy between the wages reported to the
department and the NYS tax that is withheld on those
wages.
For instance, the NYSDTF closely examines whether
an employer properly complied with the ‘‘accrual rule’’
for employees leaving or entering the state on a work
assignment.10
Application of the rule is dependent on
the type of compensation earned and the period in
which it is earned, resulting in compliance complexity
that can become significant.
Without maintaining a substantive policy preserving
adequate documentation of the employer’s withholding
7
20 N.Y.C.R.R. §171.6(a).
8
Technical Memorandum, TSB-M-12(5)I; Withholding Tax
Field Audit Guidelines (rev. April 5, 2005).
9
Id.
10
N.Y. Tax Law §639(a).
Authors’ Comment: NYS is unique in its ap-
proach. This can result in confusion for em-
ployers since the withholding tax methodology
employed by NYS for trailing compensation is
not consistent with that used by most other
states.
3
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4. procedure, an employer is at significant risk. For in-
stance, an employee’s assignment letter/contract and
Form IT-2104.1, New York State, City of New York, and
City of Yonkers Certificate of Nonresidence and Alloca-
tion of Withholding Tax, delineate the time period in
which an employee performs work in NYS and show-
case an employee’s good faith estimate of the tax that
the employer should withhold. Documents such as
these can prove invaluable for an employer to overcome
its burden in validating its withholding decisions under
examination. However, the employer will also be re-
quired to show a similar good faith effort in reviewing
other information to determine whether the estimate
given by the employees at issue is accurate.
Withholding Tables. Another frequent area of empha-
sis by the NYSDTF is determining whether an employer
utilized correct withholding tables for a given tax year.
Withholding tables are reissued yearly and describe the
taxable rates associated with given income thresholds.
Simple withholding errors are common and can occur,
for instance, when employees are paid supplemental
wages such as bonuses where the proper withholding
rate changes.
Employers can contribute to such mistakes by failing
to properly preserve or utilize an employee’s Federal
Form W-4, Employee’s Withholding Allowance Certifi-
cate, or NYS Form IT-2104, Employee’s Withholding
Allowance Certificate. Completed by the employee,
these forms instruct the employer how to calculate the
NYS tax to be withheld from the employee’s pay. The
employer should retain a copy of Form W-4 or Form IT-
2104 on file for inspection in the event of a request by
the NYSDTF for inspection or an audit.11
In addition, if an employee selects more than 14
withholding allowances, the employer must send a copy
of the paper form to the NYSDTF for review and ap-
proval and must retain proof of such forms to the de-
partment. Circumstances triggering this responsibility
arise frequently, especially in select industries, and can
result in significant audit consequences. Employers are
ultimately accountable for any withholding tax liability
as a result of failing to maintain Form IT-2104 in their
records and for failing to provide the department with
notice of an employee’s request for more than 14 with-
holding allowances.
Employer Obligations
Audit Reports allow the NYSDTF to complete a com-
prehensive field audit assessment. Any compliance
gaps existing within an employer’s withholding proce-
dures can, in turn, mean significant tax, interest and
penalties assessed against the employer. And ulti-
mately, employers remain financially responsible for all
assessments, including under-withheld tax.
If state income tax was not withheld from the em-
ployee, the individual is technically obligated to pay the
appropriate state tax on his or her individual income
tax returns. Although such an action would relieve the
employer from owing the under-withheld portion of the
tax to the NYSDTF, the reality is that employees not
having state income tax withheld from wages will often
fail to file a state income tax return. Consequently, em-
ployers may be saddled with the additional burden of
paying the under-withheld tax, as well as the additional
interest and penalties associated with its initial failure
to report and timely remit it to the state.
Considering the frequency with which employers are
ultimately held responsible for the under-withheld
amount and the substantial financial consequence re-
sulting from this failure, employers should factor this
into a compliance program’s analysis and treat it as an
essential part of an overall risk assessment. It is incum-
bent upon employers to review internal policies and
procedures to assess whether scenarios exist in which
reporting gaps could expose the employer to additional
tax, interest and penalties if ever under examination.
NYS is attentive and knows where to look. Employers
should react accordingly and develop proper internal
governance in an effort to avoid preventable audit as-
sessments.
What Can Employers Do?
There are multiple remedies employers can use to
self-correct gaps in their overall employment tax re-
porting and governance model. For instance, some em-
ployers may believe that risk exists that may warrant
proactively coming forward under NYS’s Voluntary
Disclosure and Compliance program to remediate his-
torical under-withholding. Under the program, the em-
ployer sets forth the facts and parameters of the disclo-
sure to the state with the ultimate goal to satisfy its li-
abilities. If successful, the employer can limit its
exposure, be relieved from penalties and maintain con-
fidentiality.
Alternatively, an employer may wish to undertake
the rigor of their own internal audit review akin to a
NYS withholding tax audit examination to assess risks
and compliance gaps. As part of this process, an em-
ployer can look at its current withholding policies and
determine whether to refresh and update its procedures
or implement a more comprehensive plan to strengthen
its overall level of compliance.
Regardless of any choices made by an employer and
despite the challenges associated with maintaining
compliance or facing an audit examination, employers
should always be positive and take steps to evaluate
current risks and potential future liability. A precise
road map is situation- and employer-dependent, but ul-
timately, action can prove invaluable.
Disclaimer: The views expressed in this article are
strictly those of the authors and do not necessarily reflect
any official policy or position of Ernst & Young LLP.11
20 N.Y.C.R.R. §171.4.
4
5-13-16 Copyright ஽ 2016 TAX MANAGEMENT INC., a subsidiary of The Bureau of National Affairs, Inc. TM-WSTR ISSN 1534-1550