Over the past several years, the City of Wilmington, Delaware, has been imposing multimillion-dollar City Wage Tax assessments—replete with hefty penalties and interest. The City's grounds for the assessments are aggressive to say the least, and oftentimes blatantly contrary to governing law. Reed Smith has recently represented clients who received such assessments, and cautions all employers with operations in Wilmington (or even nearby) to stand firm against the City's strong-arm tactics.
Wilmington imposes a 1.25 percent City Wage Tax ("Tax") on all wages earned while working within the city limits. The tax is also imposed on all wages earned by Wilmington residents. Employers are required to withhold the tax and report it on monthly returns. If the tax is not properly withheld and remitted, both the employer and employee are jointly liable for all tax, interest and penalties that accrue.1
The City's Aggressive Tax Assessments
The City of Wilmington's recent Tax assessments against employers fall into three basic categories:
- Assessments on wages and retirement benefits of employees who at one time worked or lived in the City, but ceased to do so before the wages or benefits were paid
- Assessments on payments made to home-based workers covered by consulting contracts
- Assessments on wages of employees who list a P.O. Box, rather than a street address, on their W-2s. Amazingly, with regard to this last category, the City's position is that the wages of every employee who lists a P.O. Box (rather than a physical street address) are subject to the Tax, because those employees must have worked in the City. The City takes this position even if the P.O. Box address is located hundreds of miles away and/or across state lines.
Assessments in all three of these categories go far beyond what is allowed by the governing statute, and taxpayers that protest these assessments often can benefit from a significant reduction in the amount of Tax assessed.
Penalties, Interest, and Statute of Limitations
As aggressive as the City's Tax assessments have been, the assessments themselves have not been nearly as aggressive as the position that the City has taken with respect to penalties, interest, and the statute of limitations. These aggressive positions can inflate the City's assessments to amounts out of all proportion to an employer's actual Tax liability.
The City can impose two types of penalties on employers that have not complied with the Wage Tax withholding requirements: (1) a 5 percent penalty for unpaid Tax; and (2) a 5 percent per month (uncapped) penalty for not filing a tax return. The City Code specifically provides that the 5 percent per month penalty may only be levied against persons who "fail or refuse to file any report or return."2
Despite the clear language in the City Code, the City has routinely taken the position that an employer that has mistakenly excluded even one employee's wages from a Wage Tax return has not filed a tax return with respect to that employee. Accordingly, in the City's view, this means that the uncapped 5 percent per month "failure to file" penalty can be applied to the unreported wages of the unreported employee, regardless of whether the employer has otherwise been wholly compliant.
The City also imposes interest on unpaid Tax at a rate of 18 percent per year (1.5 percent per month). This rate is far in excess of any market rate and operates, in effect, as yet another penalty against the taxpayer. For that reason, it is improper and likely unenforceable.3
Making matters worse, the City has been straining certain statutory provisions in order to extend the already lengthy six-year statute of limitations for assessments. The statute of limitations runs from the date that an employer files a tax return. However, the City takes the position that if an employer's Wage Tax return does not include the wages of an employee, then the employer has not yet filed a tax return with respect to the unreported wages. As a consequence, the City argues that the statute of limitations does not apply to unreported wages, even if the employer timely filed an otherwise correct Wage Tax return.4 When the City's position on the statute of limitations is coupled with the 5 percent per month uncapped "failure to file" penalty and 18 percent per year in interest, it is not difficult to see how the City can take a modest Tax understatement and convert it into a multimillion-dollar Wage Tax assessment.
What To Do if Your Company Receives a Wage Tax Assessment
Pursuant to the City Code, "proposed assessments" must be appealed within 30 days from the date they are mailed to the taxpayer.5 Because the window for filing an appeal is limited, any employer that receives a Wilmington Wage Tax Assessment should act quickly in order to preserve its rights. Preserving these rights is crucial, given the City's recent history of grossly inflated Tax assessments.