ARIZONA DEPARTMENT OF REVENUE
ARIZONA WITHHOLDING TAX RULING
WTR 92-1
This substantive policy statement is advisory only. A substantive policy statement does not include internal procedural documents that only affect the internal procedures of the agency and does not impose additional requirements or penalties on regulated parties or include confidential information or rules made in accordance with the Arizona administrative procedure act. If you believe that this substantive policy statement does impose additional requirements or penalties on regulated parties you may petition the agency under Arizona Revised Statutes § 41-1033 for a review of the statement.
ISSUE:
Arizona Withholding Requirements Imposed On Tip Income
1. When the amount required to be deducted by an employer is more than the employee's regular wage (the wages under the control of the employer) due to the requirement to withhold on tip income, does Arizona recognize the federal priorities established by Treas. Reg. § 31.3402(k)-1?
2. If Arizona does recognize the federal priorities for withholding taxes, will the employer still be required to remit the total applicable percentage of federal withholding for Arizona purposes when the amount required to be deducted by the employer is more than the amount of wages under the control of the employer?
LEGAL REFERENCES:
1. A.R.S. § 42-104.A.1 General powers and duties of the Department, which authorizes the Department to formulate policies, plans and programs to effectuate the missions and purposes of the Department.
2. A.R.S. § 43-102.1 Declaration and intent which adopts the provisions of the Internal Revenue Code relating to the measurement of adjusted gross income.
3. A.R.S. § 43-104.13 Definitions defines the "Internal Revenue Code" to mean the United States internal revenue code of 1986, as amended, and in effect on January 1, 1991.
4. A.R.S. § 43-401.A Withholding tax; rates; election by employer provides that at the time of the payment of wages, the employer, is required to deduct therefrom an amount equal to an applicable percentage of federal income tax which was deducted under the Internal Revenue Code.
5. I.R.C. § 3401(f) which defines the term "wages" to include tips received by an employee in the course of his or her employment. Such wages (tips) are deemed to be paid at the time the employee furnishes the employer with a written statement regarding the receipt of such tips, or if no statement is furnished, at the time the tips are received.
6. I.R.C. § 3402 which requires every employer making payment of wages to deduct and withhold upon such wages a tax determined in accordance with prescribed tables or a prescribed mathematical formula.
7. Treas. Reg. § 31.3402(k)-1 which establishes priorities for the application of the employee's wages to the taxes that must be withheld.
DISCUSSION:
For federal purposes, I.R.C. § 3402 requires every employer making payment of wages to deduct and withhold upon such wages a tax determined in accordance with prescribed tables or a prescribed mathematical formula. For federal withholding tax purposes, I.R.C. § 3401(f), defines the term "wages" to include tips received by an employee in the course of his or her employment. Tips are deemed to be paid at the time the employee furnishes the employer with a written statement regarding the receipt of such tips or, if no statement is furnished, at the time the tips are received.
In some instances, an employee's remuneration may consist almost entirely of tips with the regular wages being nominal. In this situation, the amount required to be withheld may be in excess of the amount of wages under the employer's control. If the amount required to be deducted by the employer is more than the employee's regular pay, the employee may voluntarily pay to the employer money which the employer may apply to withholding taxes.
If the employee does not voluntarily furnish additional funds to cover the amounts required to be withheld, Treas. Reg. § 31.3402(k)-1 establishes priorities for the application of the employee's wages to the taxes that must be withheld. Under Treas. Reg. § 31.3402(k)-1, the taxes imposed with respect to the regular wage must be satisfied first. The amounts first withheld from the regular wage must be applied in the following order: (1) I.R.C. § 3101 (F.I.C.A.), (2) I.R.C. § 3402 (Income Tax at Source) and (3) State and local taxes. After the withholding from the regular wage has been satisfied, the employer must then deduct and withhold federal taxes imposed on tip income from the remaining wage. Under the federal procedures, if the amount of remaining wage is not sufficient to cover the federal amount required to be withheld on tip income, the amount of tax which remains unsatisfied should be withheld from the wages under the control of the employer the following pay period.
For Arizona withholding tax purposes, A.R.S. §§ 43-102 and 43-104.13 conform the Arizona definition of wages to the federal definition of wages. Therefore, amounts included in wages and subject to mandatory federal withholding are likewise subject to Arizona withholding. Tips which are reported to an employer by an employee which are considered to be wages for federal purposes and subject to mandatory federal withholding are likewise subject to Arizona withholding. Arizona statutes do not have any exceptions to this requirement.
Under A.R.S. § 43-401.A, at the time of the payment of wages the employer, is required to deduct therefrom an amount equal to an applicable percentage of federal income tax which was deducted under the Internal Revenue Code. The amount of taxes required to be withheld for Arizona purposes cannot be determined until after the federal withholding amount is determined and deducted. Therefore, since Arizona's withholding provisions are subordinate to the federal provisions, Arizona is required to recognize and conform to the federal priorities established under Treas. Reg. § 31.3402(k)-1.
Under Treas. Reg. § 31.3402(k)-1, when the employee's regular wage is not sufficient to cover the entire amounts required to be withheld on tip income, the amount of funds in the employer's control (i.e., remaining regular wage) must first be applied to any required federal withholding on tips. In this situation the employer may not have sufficient wages from which to deduct the Arizona withholding. Since A.R.S. § 43-401 requires the Arizona withholding amounts to be deducted from the wages, the required Arizona withholding amount on tip income will be limited when the funds available for distribution are restricted under this Treasury regulation.
CONCLUSION AND RULING:
For Arizona withholding tax purposes, tips which are reported to an employer by an employee which are subject to federal withholding are likewise subject to Arizona withholding. In the situation where the amount of required federal and Arizona withholding on tip income exceeds the amount of wages available from which withholding may be made, the Department will recognize the payment application structure established by Treas. Reg. § 31.3402(k)-1. The employer is required to withhold as follows:
1. The employer is first required to withhold federal and Arizona taxes imposed on the regular wage.
2. After the required withholding in number 1 has been satisfied, the remaining regular wage must then be used to satisfy the required federal withholding imposed on the employee's tip income.
3. After the withholding required in numbers 1 and 2 have been satisfied, the remaining regular wage, if any, must be used to satisfy the applicable Arizona withholding on the tip income.
Therefore, in this situation, the employer is only required to withhold Arizona taxes on tip income to the extent that the tax can be deducted and withheld from the wages under the employer's control. If the current wage under the employer's control is not sufficient to satisfy the amount required to be withheld for Arizona purposes, then the employer must withhold such unsatisfied amounts from the remaining regular wage in the following pay period or succeeding pay periods during the calendar year.
Paul Waddell, Director
Signed April 27, 1992