As detailed in the original article published by Clark Nuber, in July 2020, the Seattle City Council passed City Ordinance 126108 establishing a new Seattle payroll expense tax that takes effect January 1, 2021.
Updates to the Original Tax
Following the passage of that ordinance, the Department of Finance and Administrative Services (FAS) conducted a rulemaking process and then published a Director’s Rule for the payroll tax. As a part of that process, FAS staff received numerous questions from businesses about how to apply the payroll expense allocation methodology included in the ordinance, especially in situations where employees split their time between work in Seattle and work in other jurisdictions.
In response to the questions and comments from businesses, and in an effort to make it easier for businesses to understand and effectively comply with the law, the City passed Ordinance 126309. This ordinance adds an additional method that businesses may choose to use to determine their payroll expense subject to the tax, based on the proportion of an employee’s hours worked in Seattle compared to the employee’s total hours worked in all locations.
As detailed in the previous Clark Nuber article, the original statute prescribed a methodology for determining when an employee is “primarily assigned” to Seattle based on a number of different alternative factors.
If it is determined that an employee is “primarily assigned” to Seattle, then 100% of that individual’s payroll is subject to the Seattle payroll expense tax based on a progressive tax rate schedule for businesses with more that $7M of Seattle payroll and employees with greater than $150,000 of annual compensation.
New, Alternative Methodology – The “Hours Method”
The new ordinance introduces an alternative methodology for determining the amount of compensation subject to the payroll expense tax for an individual employee that performs work partly within and partly outside Seattle.
Businesses may now elect to compute the amount of an individual employee’s compensation subject to the tax using an “hours method.” Under the hours method, the business multiplies that individual’s annual compensation by a ratio of the individual’s hours worked in Seattle to the individual’s total hours worked in all locations. So, an employee that is compensated $300,000/year and spends 60% of their time working in Seattle would be subject to the tax, at an applicable rate, on $180,000 of their annual compensation.
As summarized above, the tax only applies to employees that are paid greater than $150,000 in compensation during the year. Under the new “hours method” that threshold is determined before applying the ratio of the individual’s hours spent working in Seattle divided by total hours worked everywhere. For example, if an employee is paid $160,000 for the year and 50% of that individual’s time is spent working in Seattle, $80,000 of the employee’s payroll is subject to the payroll expense tax because total compensation paid to the employee during the year is greater than $150,000 (even though only $80,000 of that amount is subject to the tax).
Under the previous statute, the terms of which are still in effect if a business does not select the new hours method described above, an employee that was not primarily assigned to any place of business of the taxpayer and performed at least 50% or more of their services in Seattle or an employee that was not primarily assigned to any place of business of the taxpayer and that did not perform 50% or more of their service in any city and resided in Seattle would be subject to the payroll expense tax on 100% of their annual compensation.
Businesses that select to use the hours method must utilize the method for all employees for the entire tax year. Taxpayers using the hours method may also exclude from the measure of tax any compensation paid to employees working less than 40 hours in Seattle during the tax year. According to the city’s payroll expense tax rule, the city will presume 1,920 work hours for fulltime employees per year. If actual hours worked in any year are more than 1,920 hours, or they can be reasonably anticipated to be more than 1,920, the business must be able to document the increased number of actual hours for the calculation.
Next Steps for the Tax and Businesses
We expect that many businesses with employees performing work inside and outside of Seattle will find the hours method a welcome relief from what otherwise appeared to be a tax regime that unduly burdened businesses with traveling employees that resided in Seattle or with employees that were spending at least 50%, but less than 100%, of their time working in Seattle. Questions remain, however, on what type of documentation the city will accept on audit to support taxpayers’ determinations of compensation paid in Seattle under the alternative methodologies.
The City held a taxpayer training webinar on July 7, 2021, and it has scheduled another training for August 4, 2021 at 10am PST. Registration information is available by clicking here.
If you have any questions about the Seattle payroll expense tax and how it will affect your business, please contact any member of the Clark Nuber State and Local Tax group.
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