Payroll in Practice 2.28.2022

Question: A company CEO just retired and moved to another state. She will continue to serve on the board of directors and will receive a salary. Should the company withhold state income tax and pay unemployment tax to the state in which she lives or the state where the company is located?

Answer: This depends upon the duties the retired CEO performs as a “director.” If the duties include only duties as a director, as opposed to duties normally associated with a corporate officer, state unemployment tax should not be an issue, because she would be a nonemployee. However, check state laws for any withholding requirements for nonemployees. For example, North Carolina requires that North Carolina income tax be withheld for nonresidents who provide certain types of services within North Carolina.

Officers of corporations are generally employees. An exception exists for officers who perform no services, or only minor services, and are not entitled to and do not receive compensation. See Internal Revenue Code Section 3121(d)(1) and IRS Publication 15-A, Employer’s Supplemental Tax Guide.

Directors who perform only duties as a director are not employees under the common law because they represent the shareholders and are not under the direction and control of the employer or the employer’s management. Their fees are not “wages” or “salary” but are generally self-employment income. In that case, the director should receive a 1099-NEC, Nonemployee Compensation. No taxes would be withheld unless backup withholding is required. Also, the employer would not withhold or pay any employment taxes on the director fees.

However, when the director performs significant duties that would normally be assigned to an officer rather than a director, the payments are likely to be wages and reported on Form W-2. The payments may also be wages if they are more in the nature of deferred compensation than director’s fees. This could happen when the post-retirement compensation agreement is based more on past service than on future service.

If the payments are wages, then state unemployment tax would be attributable to the state in which the retired CEO performs the services. State income tax would be withheld for the state(s) in which the services are performed. However, if the payments are deferred compensation the payments may be considered trailing compensation and taxable in the state where originally earned.

If there is a reciprocal agreement between the states where the services are performed, then income tax would be withheld for the state of residence. If the employer does not have a business presence in the state of residence, then there is generally no legal obligation to withhold state income tax.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., or its owners.

Author Information

Patrick Haggerty is the owner of a tax practice in Chapel Hill, N.C., and an enrolled agent licensed to practice before the Internal Revenue Service. The author may be contacted at phaggerty@prodigy.net.

Do you have a question for Payroll in Practice? Send it to phaggerty@prodigy.net.