Seattle has passed an employee hours tax, commonly referred to as a “head tax,” which takes effect in 2019. Most are aware that the tax affects corporations, LLCs and LLPs with annual revenues in excess of $20 million “engaging in business activities” within Seattle. (Exempted from the ordinance are nonprofits and certain industries in which taxation is preempted by federal or state law.) However, there are three features of the new tax ordinance that have received little attention and that companies doing business in Seattle should know:
1. The tax is not necessarily $275 per employee. Most news outlets are reporting the annual tax as $275 per full-time employee. In fact, the actual amount may vary. The ordinance gives employers two alternative choices for calculating the amount payable: the Employee-Hours approach or the Full-Time Equivalent (FTE) approach.
Employee-Hours. Under the Employee-Hours approach, the tax owed is equal to the number of hours worked by an employee in the city multiplied by $0.143232. So an employer will pay $275 for each employee working 1,920 hours per year (approximately 37–38 hours per week depending on a 52- or 50-week year).
Full-Time Equivalent. Under the FTE approach, the employer counts the number of FTEs in a given quarter by adding (a) the number of full-time employees and (b) the number of hours worked by all part-time employees divided by 480 (which is one-quarter of the 1,920 figure from the Employee-Hours approach). The FTE figure is then multiplied by $275 to arrive at the tax.
Generally, businesses with full-time employees working more than 1920 hours per year should choose the FTE approach, whereas employers with employees that work fewer than 1920 hours per year should choose the Employee-Hours approach. Businesses with both types of employees are advised to run calculations under both approaches to determine the most tax-efficient approach. Employers may only choose one calculation methodology from year to year. (Side note: unlike the original version of the proposed ordinance, the employee hours tax will not convert to a payroll tax.)
2. Definition of “employees” creates potential interpretation disputes: The ordinance defines an “employee” as:
“any person who performs work, labor or services for a business, is on the business’s payroll, and performs any part of their duties within the City of Seattle;”
and “payroll” to include:
“salary, wages, tips, or other draws or distributions made to employees, officers, partners, or members of [LLCs] as compensation for their labor and services.” (Emphasis added.)
These definitions are unique and untested. Enforcement officials may contend that the tax applies to individuals, e.g., independent contractors and members of LLCs, who are not “employees” as defined by common law.
3. The tax must be paid quarterly or annually depending on how business license taxes are paid. The tax shall be in effect during the five-year period beginning January 1, 2019 and ending December 31, 2023. Businesses must pay this new employee hours tax on a quarterly basis if they also pay business license taxes on a quarterly basis; otherwise, the new tax is payable annually. The tax may be extended beyond five years, as the ordinance directs City Council to evaluate the effectiveness of the tax by considering such factors as the rate of employment, wages, the number of new affordable housing units constructed using proceeds from the tax, the number of homeless persons in the city, and the effectiveness of service providers funded by the tax on reducing homelessness.
Businesses affected by the head tax should work with experienced legal and financial advisors to ensure operations are structured for tax efficiency, particularly for those businesses paying LLC distributions, using independent contractors, or employing/contracting with persons living outside Seattle, but providing services with a nexus to Seattle.