Directive PD-98-3

Subject: Withholding From Nonresidents for Personal Services
Tax: Individual Income/Withholding Tax
Statute: G.S. 105-163.1(2) and G.S. 105-163.3
Issued By: Personal Taxes Division
Date: October 22, 1998
Number: PD-98-3

This directive addresses the revised withholding law requiring income tax to be withheld from nonresidents for personal services performed in North Carolina. The law was enacted in 1997 by House Bill 57, Chapter 109 of the 1997 Session Laws, and was effective January 1, 1998. The 1997 law was revised by House Bill 1318, Chapter 162 of the 1998 Session Laws and Senate Bill 1226, Chapter 98 of the 1998 Session Laws, effective retroactively to January 1, 1998. This directive amends and supersedes PTAM-97-4 dated October 13, 1997.

If you have questions about this directive, you may call the Personal Taxes Division of the North Carolina Department of Revenue at (919)733-3565. You may also write to the Division at P.O. Box 871, Raleigh, N.C. 27602-0871.

Definitions

Compensation - Consideration a payer pays a nonresident individual or nonresident entity for personal services performed in this State.

Contractor - Either of the following:

1. A nonresident individual who performs in this State for compensation other than wages any personal services in connection with a performance, an entertainment or athletic event, a speech, or the creation of a film, radio, or television program. (Under prior law, a nonresident individual was a contractor regardless of the kind of service performed. The revised law limits the kinds of services for which withholding is required to those listed in this definition.)
2. A nonresident entity that provides for the performance in this State for compensation of any personal services in connection with a performance, an entertainment or athletic event, a speech, or the creation of a film, radio, or television program. (Under prior law, a nonresident entity was a contractor for 1998 only if the service was in connection with a performance, an entertainment or athletic event, the creation of a film or television program, or the construction or repair of a building or highway. In 1999, a nonresident entity would have been a contractor regardless of the kind of service performed. The revised law limits the kinds of services for which withholding is required to those listed in this definition.)

Nonresident entity - Any of the following:

1. A foreign limited liability company that has not obtained a certificate of authority from the Secretary of State pursuant to Article 7 of Chapter 57C of the General Statutes.
2. A foreign limited partnership or a general partnership formed under the laws of any jurisdiction other than this State, unless the partnership maintains a permanent place of business in this State.
3. A foreign corporation that has not obtained a certificate of authority from the Secretary of State pursuant to Article 15 of Chapter 55 of the General Statutes.

Payer - A person who, in the course of a trade or business, pays a nonresident individual or a nonresident entity compensation for personal services performed in this State.

General Requirements

Effective January 1, 1998, North Carolina income tax is required to be withheld from non-wage compensation paid to nonresidents for personal services rendered in this State. The requirement to withhold applies to payers who, in the course of a trade or business, pay more than $1,500 of non-wage compensation to a nonresident individual or to a nonresident entity for services performed in North Carolina in connection with a performance, an entertainment or athletic event, a speech, or the creation of a film, radio, or television program.

Exceptions to Withholding

Tax is not required to be withheld from compensation paid to a nonresident entity if the entity meets certain requirements. No tax is required to be withheld if the entity is a corporation or a limited liability company that has obtained a certificate of authority from the Secretary of State. The payer must obtain from the entity and retain in its records the entity's identification number issued by the Secretary of State.

No tax is required to be withheld from an entity that is exempt from North Carolina corporate income tax under G.S. 105-130.11. This includes any organization that is exempt from federal income tax under the Internal Revenue Code. The entity must provide documentation of its tax exemption to the payer, such as a copy of the organization's federal determination letter of tax exemption or a copy of a letter of tax exemption from the Department of Revenue. (Prior law did not provide an exception for non-profit corporations.)

If an entity is a partnership, no tax is required to be withheld if the partnership has a permanent place of business in this State. The payer must obtain from the partnership and retain in its records the partnership's address and taxpayer identification number.

Tax is not required to be withheld from personal services income paid to an individual who is an ordained or licensed member of the clergy or who is a resident of North Carolina. The payer must obtain from any individual from whom the payer does not withhold because the individual is a resident of this State the individual's address and social security number and retain this information in its records.

Threshold

Withholding is required if the contractor is paid or is expected to be paid more than $1,500 during the calendar year ($600 under prior law). Tax is not required to be withheld from a payment of compensation to a contractor if the payment is $1,500 or less and, at the time the payment is made, the payer does not believe that the total compensation to be paid to the contractor during the year will exceed $1,500. If additional compensation paid to the contractor later in the year causes total compensation for the year to exceed $1,500, the payer is not required to withhold tax from the additional compensation to make up for the compensation from which no tax was withheld. For example, the payer pays a nonresident $900 in January, 1999, and does not expect to make any further payments to that nonresident in 1999. Since the compensation is $1,500 or less, no tax is withheld. Later in 1999, the same nonresident is paid an additional $800. The payer must withhold $32 from the $800 compensation ($800 x 4%) because the total compensation paid to the contractor for the year now exceeds $1,500. (The Department's previous policy required the payer to withhold sufficient tax from the additional compensation to make up for the compensation from which no tax was withheld.) In contrast, if the payer makes regular payments to the contractor during the year, the total of which is expected to exceed $1,500, tax must be withheld from each payment.

When Services Are Performed in North Carolina

Withholding is required only if the compensation is paid for services performed in this State. In most cases, the nonresident contractor will provide the service entirely in North Carolina; in those instances, tax must be withheld from the total amount of compensation. If the nonresident contractor performs the contracted services in more than one state, the payer must withhold North Carolina tax only from the portion of the compensation that is attributable to this State. In determining the portion of the compensation subject to withholding of North Carolina income tax, a nonresident contractor performing contracted services in North Carolina and in one or more other states must use a method of determining North Carolina source income that fairly and equitably apportions and allocates the compensation for services rendered in North Carolina.

A contractor must use the "duty day" method to allocate the compensation to North Carolina unless the contractor has received written permission from the Secretary of Revenue to use a different method. A duty day is any day or part of a day in which an activity connected with the service is performed. This includes, but is not limited to, meetings, delivery of products, and promotional activities. The contractor's North Carolina source income is determined by multiplying the total compensation for the contracted service by a fraction, the numerator of which is the number of duty days spent in North Carolina rendering services under the contract and the denominator of which is the total number of duty days spent both within and outside of North Carolina during the taxable year in rendering services under the contract. For example, a foreign corporation enters into a contract for $100,000 to provide a performance in North Carolina. The corporation's representative spends one day in North Carolina viewing the location of the performance and discussing other contractual matters. The corporation spends thirty-nine days outside North Carolina preparing for the performance and another ten days in North Carolina performing. The North Carolina payer must withhold $880 from the compensation paid to the contractor [($100,000 x 11/50) x 4%].

The Secretary may determine that the duty day method of determining North Carolina source income does not equitably apportion and allocate the compensation for services rendered in North Carolina. In those cases, the Secretary may require a different method of apportionment. The revised method of apportionment will be applied prospectively with respect to the amount of tax to be withheld but may be applied retroactively to the contractor's determination of its income tax liability.

If the contractor believes that the duty day method of determining North Carolina source income does not equitably apportion and allocate the compensation for services rendered in North Carolina, the contractor may submit a proposed alternate method in writing for the Secretary's approval. The payer shall withhold using the duty day method until the Secretary approves an alternate method.

Reporting and Paying the Withheld Tax

A payer who withholds tax from personal services income but who is not already registered with the Department of Revenue for wage withholding must register by completing Form AS/RP1, Registration Application for Sales and Use Tax and/or Income Tax Withholding, and returning the form to the Business Registration Unit at Post Office Box 25000, Raleigh, North Carolina 27640. The payer will be assigned an account identification number, will receive forms for paying the tax withheld from personal services income, and will pay the tax on a quarterly basis.

A payer who withholds tax from personal services income and who also withholds tax from wages must report the withholding from personal services income with the wage withholding unless the payer elects to report the withholding from personal services income separately from the wage withholding. For those payers who do not elect to report the two types of withholding separately, the payment of tax withheld is due at the time the withholding from wages is due and the payer will be subject to penalties and interest on both types of withholding based on that due date. A payer electing to report the withholding from personal services income separately will be assigned a separate account identification number for the withholding from personal services income, will receive special forms for paying the tax withheld, and will pay the tax on a quarterly basis.

A payer who initially elects to report the withholding from personal services income separately may, at any time, begin reporting the two types of withholding together. A payer who initially reports the two types of withholding at the same time may elect to begin reporting the withholding from personal services income separately by notifying the Business Registration Unit. The payer must continue to report the two types of withholding together until the payer receives the separate account identification number and remittance forms from the Department. In either case, the payer must file separate annual reconciliations for the year in which the election is changed (See Annual Statements below).

Annual Statements

A payer must give each contractor from whom tax was withheld duplicate copies of a written statement containing all of the following information:

• the names, addresses, and taxpayer identification numbers of the payer and the contractor.
• the total amount of compensation paid to the contractor during the calendar year.
• the total amount withheld from the amount paid to that contractor during the calendar year.

Payers must report personal services income and the tax withheld on Form NC-1099PS. For compensation paid to individuals, the payer may complete federal Form 1099-MISC in lieu of Form NC-1099PS. The statement must be given to the contractor on or before January 31 following the calendar year in which the compensation is paid. If the personal services are completed before the end of the year, the statement must be given within 45 days of the last payment of compensation only if the contractor requests the statement at that time. The payer must file an annual report with the Department of Revenue reconciling the amounts withheld from each contractor. Taxpayers choosing to treat withholding from personal services income as wage withholding must report the two types of withholding on one annual reconciliation report. Taxpayers subject to both wage withholding and withholding from personal services income who report the two types of withholding separately must file separate annual reconciliations for each type of withholding. The annual reconciliation for withholding from personal services income is due on or before February 28.

Claiming Credit for Tax Withheld

Individuals having tax withheld from personal services income should claim credit for the tax withheld on the same line on the individual income tax return, Form D-400 or Form D-400EZ, as credit is claimed for wage withholding. A line has been added to the C corporation franchise and income tax return, Form CD-405, for credit to be claimed for amounts withheld. Partnerships, including limited liability companies filing as partnerships, may claim credit on the partnership income tax return, Form D-403, for the portion of the tax withheld that is attributable to nonresident partners on whose behalf the managing partner is required to pay tax. The portion of the tax withheld that is attributable to resident partners must be allocated to those partners on Schedule NC K-1. S corporations may claim credit on the S corporation franchise and income tax return, Form CD-401S, for the portion of the tax withheld that is attributable to shareholders on whose behalf the corporation files a composite income tax return. The portion of the tax withheld that is attributable to shareholders who are not part of a composite return must be allocated to those shareholders on Schedule K of the S corporation return.

Refund of Tax Withheld in Error

A payer who improperly withholds tax from personal services income may refund the amount withheld in error to the contractor, including amounts properly withheld under prior law but no longer required as a result of the amendments to the law, if the refund is made before the end of the calendar year and before the payer furnishes the person the annual statement of tax withheld. A payer who makes a refund should not report the amount refunded on the annual statement nor remit the amount refunded to the Department. If the amount refunded has already been remitted, the payer must reduce the next payment of tax withheld from compensation paid to that person by the amount refunded. If no additional compensation is due to be paid to that person, and the amount withheld in error has already been remitted, the payer may not refund the tax withheld in error. The contractor must file an income tax return and claim credit for the tax withheld.