Withholding State Reporting Beyond an Organization’s Physical Presence

October 28, 2019
Paul Ogawa


Tax information reporting and withholding at the state level is often a complex undertaking for organizations to manage. With 43 states now requiring income tax withholding and reporting, and each state having its own specific requirements, compliance can be a logistical nightmare.

To add to the mounting complexities of state reporting, organizations need to have a good understanding of their state reporting requirements based on where their customers are located. For state withholding and reporting relating to life insurance contracts and annuities, withholding and reporting is required based on the locality of the recipient of the distributions that were withheld on and reported.

What many organizations do not consider throughout the state reporting process is that their customer’s geographic footprint is likely vastly different and larger than that of their organization’s geographic footprint, which opens them up to state reporting obligations beyond their organization’s physical presence. If state withholding and reporting is applied incorrectly, this could lead to state audits, penalties, loss of reputation and a poor customer experience.


Bob withdraws funds from a retirement account maintained by ABC Life Insurance and elects to withhold at 3% using Form W-4P. ABC Life Insurance now has an obligation to remit withholding and report the distribution but is unaware of where to report. ABC Life Insurance is located in State A, while Bob lives in State B. ABC Life Insurance does not have operations in State B, so it does not report Bob’s information to State B. In fact, ABC Life Insurances does not report Bob’s information at the state level at all.

However, Bob still receives his Form 1099 stating how much was withdrawn from his account for the past year and how much was withheld to State B, so Bob reports this information on his 1040. State B then sees that Bob is stating he withdrew funds from a retirement account and money was remitted to the state by ABC Life Insurance, but ABC Life Insurance did not report the information required by State B. So, the state warrants an audit on ABC Life Insurance’s state reporting process to find out that the company intentionally disregarded reporting Bob’s information to the state and issues a penalty for intentional disregard.

Why Compliance Matters

To Organizations:

Generally, withholding remittance and reporting on the state level revolves around the residency of the recipient: the distribution may or may not be seen as income, and the recipient is either obligated to report or does so voluntarily using state versions of the W-4P. As a result, the payer of said distribution must remit and report to the locality of the recipient in order to “close the loop” on payment remittance and information reporting: failing to do so leads to an inconsistency in the information a state has at its disposal, which may lead to further investigation and possible penalties from that state.

State penalties for a failure to report and remit can range from a fixed dollar amount per return to a percentage of the tax owed to the state. In some situations, the penalty for information returns (1099s, for example) are capped, but a willful or negligent failure to remit or report withholding can result in severe and unlimited penalties, which are sometimes at the discretion of state departments of revenue.

Payers must also consider their reputations and their ability to operate in a given state. If recipient taxpayers discover that an inconsistency in their taxes was the result of a failure by their financial institution to abide by compliance requirements, it could lead to a loss of business and a stain on the payer’s public reputation. Furthermore, a failure abide by statutory requirements or tax regulations issued by a state could lead to possible consequences impacting a payer’s ability to operate in a state. Several states have statutory language indicating that a willful failure to abide by remittance and reporting requirements can lead to a revocation of business operating licenses.

To Governments:

Governments have a clear interest in tax compliance: they want the money they are owed. Statutes and regulations are put in place to provide guidance to businesses and taxpayers alike, and all three parties must work together to complete the reporting and remittance cycle that flows through the taxpayers and to the government’s accounts and data centers.

To Customers:

Customers have a vested interest in information reporting and withholding compliance: not only is their private information at stake, but any errors in remittance or reporting affect their returns and tax compliance. Customers depend on organizations to properly withhold and report, assuming these organizations are aware of the regulatory requirements tied to the distributions they as payees receive. If there are any misconceptions regarding withholding obligations, the customer becomes an aggrieved party who is largely blameless but must suffer at least some blowback in the form of an audit and related expenses. As previously stated, this translates into a blow to customer satisfaction and loyalty.


Understanding withholding remittance and reporting on a state level is a complex undertaking with a myriad of requirements which vary from state to state. Understanding consequential penalties is also critical to understanding the greater picture that is tax information reporting compliance.

For state withholding and reporting relating to life insurance contracts and annuities, withholding and reporting is required based on the locality of the recipient of the distributions that were withheld on and reported. This principle is part of a greater withholding and reporting ecosystem and provides a complete picture of the transactions at play. While several states have additional requirements that may impact reporting, it is generally true that the recipient’s state of residence is undoubtedly a part of that cycle.

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Paul Ogawa

Paul Ogawa is a Senior Regulatory Counsel at Sovos Compliance. As part of the Regulatory Analysis team, his main areas of focus are state and federal tax withholding, the Affordable Care Act (ACA), and Canadian tax information reporting. Prior to Sovos, Paul worked as a litigation attorney in Boston area law firms, representing clients in insurance subrogation claims, family law matters, and employment disputes. Paul is a member of the Massachusetts Bar, earned his B.A. from Brandeis University and his J.D. from the Suffolk University Law School.
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