multistate partnerships: mastering state taxation of...
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Multistate Partnerships:
Mastering State Taxation of Corporate Partners
WEDNESDAY, OCTOBER 26, 2016, 1:00-2:50 pm Eastern
FOR LIVE PROGRAM ONLY
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FOR LIVE PROGRAM ONLY
Multistate Partnerships: Mastering
State Taxation of Corporate Partners
October 26, 2016
Ned Leiby
KPMG LLP
Jennifer A. Zimmerman
Horwood Marcus & Berk
Dátus Tomasovich
KPMG LLP
JoAnna Simek
BKD, LLP
Notice
The following information is not intended to be “written advice
concerning one or more Federal tax matters” subject to the
requirements of section 10.37(a)(2) of Treasury Department
Circular 230.
The information contained herein is of a general nature and is not
intended to address the circumstances of any particular individual
or entity. Although we endeavor to provide accurate and timely
information, there can be no guarantee that such information is
accurate as of the date it is received or that it will continue to be
accurate in the future. No one should act on such information
without appropriate professional advice after a thorough
examination of the particular situation.
4
Dated Material
THE MATERIAL CONTAINED IN THESE COURSE MATERIALS IS CURRENT AS
OF THE DATE PRODUCED. THE MATERIALS HAVE NOT BEEN AND WILL NOT
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5
Notice ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE
SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER
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You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation,
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provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained
in those materials.
The information contained herein is of a general nature and based on authorities that are subject to change.
Applicability of the information to specific situations should be determined through consultation with your
tax adviser.
6
STATE TAXATION OF
PASS-THROUGH ENTITIES
Key Issues and Current Developments
7
Partnerships
General Partnerships
Limited Partnerships
Joint Ventures
Alliances
Private Equity Funds
Hedge Funds
Multi-member LLCs taxed as partnerships
SMLLCs (“disregarded entities”)
S corporations
Specialized Entities: RICs, REITs, REMICs, Cooperatives and Some Trusts
(Note: we will reference “PTEs” and “partners”)
How We Define “Pass-Through Entities”
8
Entity vs. Aggregate
Example of Structure & Various Chains of Ownership
(The “Fund”)
Limited
Partnership
(“LP”)
LLC
OP,LP
(Operations)
Limited Partners Shareholders (Foreign &
Tax-Exempt)
Blocker Corp
LLC/LP
General
Partner
CORP
9
The last 20 years reflect a substantial increase in the use of
PTEs
The increase was driven by federal tax law and state entity
laws
Corporate income tax was declining at the same time
government revenue needs were increasing
Pass-through planning was led by federal tax benefits:
avoidance of double taxation, maximization of losses and
incentives and allowance for flexibility
Brief History of PTEs
10
Income tax generally not imposed at the entity level
Composite return distinction
Partnership may be required to file a return in states where partner lives
even if entity has no other connection with the state
Generally reporting on a separate entity basis (i.e., no combined reporting)
Partnership tax law generally articulated under individual tax law, not
corporate tax law
Watch for differences in apportionment/allocation, depending on partner type.
Multi-tiered structures present additional complexities, pitfalls, and
opportunities
Corporation vs. Partnership –State Taxation
Differences
11
State-Federal Conformity Issues
12
The issue of federal-state conformity actually raises two
separate questions:
#1 - Characterization: Does the state’s tax law follow the
federal characterization of the PTE under the “check-the-
box” rules?
#2 - Pass-through Treatment: Does the state’s tax law follow the
federal tax treatment of income of “partnerships” and
“disregarded entities”?
State Conformity Overview
13
#1 – Characterization
Most states respect entity characterization under federal
“check-the-box” regulations
An LLC that is a disregarded entity for federal tax is a
disregarded entity for state tax purposes
Some Notable (Income Tax) Exceptions:
MA (large S corporations and SMLLCs are taxable as S Corp if
owned by S Corp)
NH (all PTEs taxed at entity level, even sole proprietorships)
RI (corporate-owned SMLLC is taxed as a C Corp)
14
#2 – Pass-Through Treatment
Most States Also Follow Federal Pass-through Treatment
No tax on the PTE, but tax on the partners
Some Notable Exceptions and Variations:
Entity-level taxes (IL, NH, ME, OH, OK, TN, TX)
Don’t forget local jurisdictions (Philly, DC, NYC)
Entity-level capital stock and fees (NY, PA, others)
Withholding/estimated tax/partner consent rules (many)
Composite filing rules (many)
Some States Also Provide Exemption for Investment
Partnerships and Their Partners
15
Reminder of “Other” Filings
Remember that PTEs are generally not disregarded
for non-income taxes, including:
State registrations and filing fees
Non-Income Taxes:
Most Sales and Use Taxes
Some Franchise / Privilege Taxes
Excise Taxes (“sin taxes” – tobacco, alcohol, etc.)
Property Taxes
Real Estate Transfer Taxes
Employment Taxes
16
Corporation vs. Partnership –State Taxation
Differences
Different nexus rules may apply
Factor presence/economic nexus may apply only to corporations (NY)
Tax base
Depreciation
COD income IRC § 108(i) conformity
Step-ups/downs (IRC § 754)
Different apportionment factor weighting and sourcing
Examples
NY-Partnership equally weighted 3 factor and cost of performance for sourcing
NY-Corp single sales factor, market based sourcing
CT-2015 different, aligned 2016
PA-differences
17
Conformity Conflicts
“Jurisdictional Mismatches” may occur. Example:
– PTE operates solely in NH; 70%
corporate partner domiciled in
UDITPA state, conducts business
in many states; PTE distributive
share is “non-business” income
– NH: Applies entity-level tax on
PTE (BPT & BET) using water’s
edge combination apportionment
factors (no business/non-business
distinction)
– Domicile state: taxes entire 70%
share of “nonbusiness” income to
the Partner in state of commercial
domicile
NPH
LLC
70%
Corporate
Partner
Multistate Business
Domiciled in UDITPA
State
$ Distributive Share =
Non-business Income
100% in NH
PTE
Partner
18
Entity vs. Aggregate
Compliance, Reporting and Planning Considerations
Nexus Business/Nonbusiness
Determination Unitary vs
Non-unitary Apportionment
19
Nexus Issues Affecting Partners
20
Central Nexus Issue
Key Nexus Question:
May a state in which the PTE is doing business subject a
nonresident corporate partner to the state’s corporate income
(or franchise tax) on its distributive share of partnership
income, even if the corporate partner has no independent
activity in the state?
Key Policy Question:
Is it appropriate to tax a nonresident limited partner on its 2%
distributive share but not a nonresident shareholder on its 2%
stock ownership in a corporation?
21
Constitutional Framework
Due Process Clause
Two requirements: (1) Taxpayer must have sufficient “minimum contacts” with
the taxing state and (2) income must have a “rational relationship” to intrastate
values of the enterprise
Concern is the “fundamental fairness of government activity” (Quill Corp.
(1992))
A state may not subject to tax a nonresident on its ownership of stock in a
domestic corporation under the DPC (Shaffer v. Heitner (1977))
Commerce Clause
Four Part Test: (1) Substantial Nexus, (2) Fairly Apportioned, (3)
Nondiscrimination, (4) Fairly Related (Complete Auto (1977))
“Unitary” Principles
The “lynchpin of apportionability … is the unitary-business principle” (Mobil
Oil (1980))
22
General Rule
General Rule: The vast majority of states consider a
corporation’s ownership of an interest in a partnership doing
business in the state to be sufficient to create nexus for the
corporation, even if the corporate partner has no other
contact with the state.
Issues:
What theories support this conclusion?
What constitutional principles prohibit taxation?
Does the same rule apply to members of LLCs?
Does the same rule apply to limited partners?
23
How Have the Cases Come Out?
Borden
(IL 2000):
NRLP
taxable
because LP
interest is
sufficient
“minimum
connection”
Non-Resident Limited Partners (NRLP”) TAX
NO
TAX
Village SM
(NJ 2013):
NRLP taxable
because LP
had in-state
presence /
connection
UTELCOM
(LA 2011):
NRLP not
taxable –
under state
statute
BIS (NJ 2011) / Dutton (VA 2007):
NRLP with no connections not taxable
– under Constitution
Lanzi
(AL 2006):
NRLP not
taxable -
under
Constitution
(akin to
stock)
24
Entity vs. Aggregate Flow-Through Entities – Nexus to Corporate Partners
(Qualified) Investment Partnership Exceptions
Qualified Investment Securities- Defined by state. Generally an asset and income test.
• Corporate partners must combine share NY receipts from partnership with
their own NY receipts to determine if they meet $1 million gross receipts
nexus threshold. New law effective 1/1/15- Aggregation requirement.
Corporate Partner - California
Deemed to be doing business in state and unitary with partnership if general
partner
$800 minimum tax
No consideration given to % ownership of partnership with respect to
unitary determination
If unitary, % of apportionment factors will flow through and be combined with factors of corporation
Unitary status unlikely if corporation is a limited partner. California SBE has
declared in opinions that it is extremely difficult to overcome the inherent
passive investment nature of a limited partner interest.
Oregon: Is the partner an “excise tax” or “income tax” payer?
25
Ancillary Nexus Issue #1 – “Nexus Only”
Key Issue: Some states require (or allow) combined/consolidated returns
only for corporate affiliates that have nexus with the state (“nexus-only”
filings). See Iowa Code Sec. 422.37(2). Does an out-of-state partner qualify
as a “nexus” member solely on the basis of the activities of in-state PTE?
Example: A and C are eligible, but is B by virtue of PTE?
Corp B
(no nexus)
PTE
(nexus)
Corp D
(no nexus)
Corp C
(nexus)
Corp A
(nexus)
26
Ancillary Nexus Issue #1 – “Nexus Only”
Considerations:
Yes, but only if the Partner B is taxable in the state by virtue of the PTE’s
activities? So, does this mean that a 2% GP may be an eligible member
but a 2% LP may not? What impact could this have on the return?
No, if Partner B is only a passive limited partner because a corporate
shareholder would not be taxable by virtue of its subsidiary’s nexus?
No, if the state consolidated return statute can be strictly construed to
only include the corporate member (Partner B) based on its own
individual activities?
27
Ancillary Nexus Issue #2 – Throw-Back,
Throw-Out, Joyce/Finnegan
Situation 1: Should a corporate
partner’s sales to a destination state
where it has no independent nexus
be thrown back if the PTE has nexus
in the state but it does not?
Situation 2: Should a PTE’s sales to
a destination state where is has no
independent nexus be thrown back if
the corporate partner has nexus in
the destination state but it does not?
Partner
(State A)
PTE
(State B)
State A
Partner
(State A)
PTE
(State B)
State B
28
Ancillary Nexus Issue #2 – Throw-Back,
Throw-Out, Joyce/Finnegan
Considerations:
No throwback in either case in states that attribute the activities of the PTE to
the partner (e.g., the partner has nexus in the state)?
No throwback only in Situation 1 because a partner can have nexus in the state
by virtue of the PTE but a PTE cannot have nexus in a state by virtue of a
partner?
Does it matter if the state adopts Joyce or Finnegan?
In Joyce states, a PTE’s sales (Situation 2) may be subject to throwback despite the fact that the
partner has nexus because each entity’s factors are calculated independent of the others.
Does it matter if the PTE can be an eligible “member” of a unitary group as opposed to just
corporations being eligible members?
What is the right answer from a policy perspective?
Should you evaluate a “nexus” position to prevent throwback?
29
Ancillary Nexus Issue #3– PL 86-272 Key Issue:
PL 86-272 generally precludes a state from imposing an income tax on an entity
whose activities within the state are limited to solicitation of sales of TPP and
ancillary activities. Should the activities of an in-state PTE that exceed PL 86-272
subject the out-of-state partner to tax?
Considerations:
Similar considerations as throw-back – who is the taxpayer?
MA: if a foreign corporate partner is unitary with its in-state partnership, the
activities of the partners are deemed to be the activities of the partner for
determining whether the income if the partner is precluded under 86-272 (830
CMR 63.39.1(8)(a))
Does PL 86-272 apply to the income derived from the PTE? Or does PL 86-272
apply to the corporate partner as the taxpayer under the corporate income tax?
30
Ancillary Nexus Issue #3– PL 86-272 Example: Arizona Dept. of Rev. v. Central Newspapers (11/3/09):
Holding: AZ may include Ponderay’s sales in the Partners’ sales factor numerator
because the taxpayer is the Parent and its activities exceeded 86-272. 86-272 does not
make certain income tax-exempt – it prevents a state from exercising taxing
jurisdiction over a corporate partner.
Partners
Ponderay
• Partners = no AZ nexus; Parent has AZ nexus
• Ponderay = AZ nexus but protected by 86-272
• Parent elected to file as part of consolidated
AZ return, including Partners
• Agreement that Ponderay distributive share
was business income included in AZ return
• Issue: whether Ponderay’s sales are
excluded from the consolidated return sales
factor numerator on the basis of 86-272?
13.5%
Parent
31
Division of the Tax Base -
Apportionment
32
Key Question:
Once the partner is taxable and the amount and character of the PTE’s
tax base has been determined, what method is used to “divide” the
partner’s tax base among the states to accomplish fair apportionment?
Different Approaches:
1. Partner Level (Unitary) Method
2. Partnership Level (Non-Unitary) Method
3. Business/Nonbusiness Income Classifications
4. Methods for Special Issues
Central Tax Base Issue
Note: Reporting apportioned income and apportionment percentage does not satisfy requirement (or partner need) to report the partner’s share of apportionment factor(s).
33
The share of partnership income and factors is combined with
the partner’s income and factors in determining the corporate
partner’s state taxable income
Some states require a “unitary” or “business income”
determination prior to “flow-up”
IL: 86 Ill. Admin. Code 100.3380(d) – flow-up if unitary
CA: Cal. Code Regs. Tit. 18, s. 25137-1 – flow-up if unitary
MA: 830 CMR 63.38.1 - flow-up if engaged in “related business
activities”
Others (e.g., FL) do not. Constitutionally suspect?
Consider the impact on tax base and apportionment!
#1 – Partner (Unitary) Level Method (“Flow-Up” / “Aggregate” / Combined” / “Unitary”)
34
Partner Level (Unitary) Example
Corporation A’s State Tax Return:
1. Business income / unitary (GP + 80% capital)
2. Tax Base ($600,000) is included in Corp A’s
pre-apportioned state tax base
3. Corp A’s 80% “share” of PTE’s factors is
combined with its own factors in apportioning
Corp A’s entire income to state
Corporation A
• General partner – active management
• 60% Profits Interest / 80% Capital Interest
• Distributive Share: $600,000
• Same line of business as PTE (retail)
• Retail
PTE
A
35
California If partners are unitary with partnership, then partnership’s factors flow-up to the unitary
partner(s).
If partner(s) are not unitary, then no flow-up
If partner(s) and partnership are not unitary, but the income is considered business income,
then partners must apportion partnership income separately from their other business
income.
California's regulation regarding the treatment of partnership income does not distinguish
between a limited and general partnership interest. Because partnership law prohibits a
limited partner from exercising a management role with respect to a limited partnership,
absent a unitary relationship between the general and limited partner, unity between the
limited partnership and its limited partners on the basis of strong centralized management is
unlikely. However, combination may be a consideration if the partnership and the limited
partner share operational ties.
Entity vs. Aggregate Calculation of Apportionment Factor
36
Entity vs. Aggregate
California-Sample Reporting of Apportionment Data to Partner
37
Entity vs. Aggregate Calculation of Apportionment Factor
Illinois A partnership is required to use combined reporting when engaged in a unitary business with
one of its partners. If unitary, the partner's distributive share of the business income and
apportionment factors of the partnership must be included in that partner's business income
and apportionment factors. If the partner had no other activities in Illinois, the partner would
apportion the sum of it income plus its share of the partnership income to Illinois using the
partnership Illinois sales factors and the partnership everywhere sales factors. In determining the
business income of the partnership, transactions between the unitary partner, or members of its
unitary business group, and the partnership are not eliminated. However, all transactions
between the unitary business group and the partnership are eliminated for purposes of
computing the apportionment factors of the partner and of any other member of the unitary
business group. Ill. Admin. Code tit. 86, § 100.3380(d). However, this rule does not apply:
1. to shares of income from partnerships whose business activity outside the United States is 80 percent
or more of its total business activity;
2. where the partnership has a different apportionment method than the corporate partner; or
3. where the partnership is not in the same general line of business or a step in a vertically structured
enterprise with the corporate partner. Ill. Admin. Code tit. 86, § 100.3380(c).
38
Entity vs. Aggregate
Illinois – Tiered Partnership Structure
If a partnership and a partner are engaged in a unitary business and the partnership is a partner in a second
partnership, the partner's share of the first partnership's share of the base income apportioned to Illinois by
the second partnership must be included in the partner's Illinois net income. This treatment applies if the
partner is not engaged in a unitary business with the second partnership. However, if the partner is engaged in a
unitary business with the second partnership, the partner's share of the first partnership's share of the business
income and apportionment factors of the second partnership must be included in the partner's business income and
apportionment factors.
If the partnership is a partner in a second partnership and one of its partners is engaged in a unitary business
with the second partnership, that partner must include in its business income and apportionment factors its
share of the partnership's share of the second partnership's business income and apportionment factors. (See
Example later in this deck)
Generally, when a corporation's activities and its partnership's activities are not considered to be in a unitary
group, the partnership allocates its nonbusiness income and apportions its business income which is then
added to the corporation's other business income apportioned to Illinois and nonbusiness income allocated
to the state. The Illinois income is calculated at the partnership level and merely reflects the partner's share
of the partnership income as post–apportionment income or loss.
39
Entity vs. Aggregate
Data Gathering
Line 1, 2, 3 are
net income. For factor-flow-
up purposes, these numbers
are irrelevant.
Note: P&L % may be different
than capital %
40
Entity vs. Aggregate
Data Gathering
Gross Revenue = Partner’s % of Lines 1,4-
7. Net amounts may require further digging
for gross revenue. Note potential tiered
flow-through issue for line 4
Line 6 – Gross or Net?
Line 7 can be many different items (+ & -)
41
Make special note of items of foreign income
flowing through as this may impact
apportionment.
Entity vs. Aggregate
Data Gathering
Foreign Gross Income (Line 16f)
should be noted
Make special note of items of
foreign income flowing through as
this may impact
apportionment.
42
The partner’s share of partnership income is apportioned by
the partnership’s factors separate from the partner’s other
income and factors.
Often applies if “non-unitary” relationship is found.
IITA Sec. 305(a) and (b))
MA: 830 CMR 63.38.1(4)(d): separate accounting applies if corporate
limited partner owns less than 50% of capital or profits interest (directly
or indirect) of partnership under presumption that activities of the
partnership are “unrelated” (rebuttable by Commissioner)
Some states (e.g., OK) require that allocation and apportionment occur at
the partnership level, regardless of unitary relationship.
#2 – Partnership Level (Non-Unitary) Method (“Separate Accounting” / “Allocation”/ “Non-Unitary”)
43
The partners then allocate this post-apportioned share of
state-sourced income separately
The allocation rules may differ!
Compare the impact on tax base and apportionment with the
Partner Level Method!
Whether the result is favorable depends on the facts…
Under Partnership Level Method, if PTE is in an income position and has high in-
state factors = potential for substantial tax liability to the partner.
Under Partner Level Method, high income position and factors from PTE may be
offset against partner losses and/or apportionment dilution
#2 – Partnership Level (Non-Unitary) Method (“Separate Accounting” / “Allocation”/ “Non-Unitary”)
44
Non-unitary Partnership Income Reporting
Non-unitary partnership income (loss) is directly allocated to the state based on amount(s) reported on State K-1, K-1 equivalent or footnotes
Factors are not flowed-up/Apportionment is not recalculated
Amount of non-unitary income (loss), including separately stated items, is separated and removed from the tax base and reported separately from the amount of base income subject to apportionment.
45
Partnership Level (Non-Unitary) Example
• Net Income: $1,000,000
• Business: Retail
• Apportionment = 75%
Corporation A
• Limited Partner (no active management)
• 40% Profits Interest / 40% Capital Interest
• Distributive Share: $400,000
• Business line different from PTE
Corporation A’s State Tax Return:
1. Business Income (partner level determination)
2. Non-Unitary (LP/no control + 40% capital)
3. Corp A’s State Taxable Income from PTE = $300,000
$400,000 distributive share
x 75% partnership factors
4. $300,000 is added to A’s other post-apportioned
income
A
PTE
46
Non-unitary Partnership Income Reporting
California Example
Non-unitary Partnership Income
Removed from base income
subject to apportionment.
Non-unitary partnership
income removed from tax
base and not subject to
apportionment by corporate
partner on Line 10.
47
Non-unitary Partnership Income Reporting
California Example
Allocate CA sourced
amount directly on line 28
(after apportionment)
48
Non-unitary Partnership Income Reporting
Illinois Example
IL-1120:
Non-unitary
Partnership
Business
Income
IL-1120:
Non-unitary
partnership business
Income removed from
business/apportionable
income (line 25).
K-1 amount sourced to
IL reported on line 33
(after apportionment of
business income)
49
Key Issue:
In some states, if a “business/nonbusiness income” regime exists, and the
distributive share is determined to be nonbusiness income, such income
is allocated to the appropriate state, instead of apportioned (e.g., to the
state of domicile or other sourcing rules applicable to nonbusiness
income).
Considerations:
Do the allocation rules look to the partner or partnership? For
example, if dividend income is allocable to domicile, do you look to the
partner’s or the partnership’s commercial domicile?
What is the impact if it is non-business income as opposed to business
income?
#3 – Business / Nonbusiness Issues
50
Business v. Non-Business Income
Transactional Test
Income arising from transactions and activity in the
regular course of the taxpayer's trade or business
Functional Test
Includes income from tangible and intangible property if
the acquisition, management, and disposition of the
property constitute integral parts of the taxpayer's regular
trade or business operations
51
Transactional Test
Identify transactions and activity occurring in the
regular trade or business
Generally, all transactions that are dependent upon or
contribute to the operations
Three standard tests:
Frequency and regularity of transactions
Former business practices
Subsequent use of proceeds (reinvestment or
distribution)
52
Functional Test
Identify whether the transaction is an integral part of
the taxpayer’s trade or business
Focus on whether property was used in trade or business
Frequency is generally irrelevant
In the case of a disposition of assets, state may look at
whether the disposition itself is an integral part of the
business operations (e.g., IA, AL, TN, NC, IL, PA)
53
54
Business v. Non-Business Income
Minnesota
Firstar Corp v. Commr. Rev.
Capital gain from sale of office building was nonbusiness
income
Applied transactional test
Infrequent: Taxpayer had not previously sold commercial
property
Subsequent use of proceeds: Not reinvested in the ongoing
business operations – treated as dividend to shareholders
55
Business v. Non-Business Income
California
Jim Beam Brands Co v. FTB
Gain from the sale of a unitary subsidiary is business income
Applied functional test
Gain was business income because the property while owned
by taxpayer was used to produce business income
Court rejected argument that disposition of property is not an
integral part of the business
56
Business v. Non-Business Income
Is business/non-business income determination made
at:
The partnership level?
The partner level?
Not much guidance; only a handful of states have
addressed in public guidance
57
At what level is the business income determination
made- partner or partnership level:
Most states have no guidance.
Exceptions:
Partnership Level: AL, CA, IL
Partner Level: AZ, PA
If non-business income, the question is to which state
is the income sourced?
#3 – Business / Nonbusiness Issues
58
Entity vs. Aggregate
Business/Nonbusiness Determination
• Majority of states have not addressed
For corporate partners is the business/nonbusiness
income determination made at the partnership level or partner level?
• Requires partner level determination
• Arizona Corporation Tax Ruling No 94-2 (4/4/1994)
• Illinois Admin. Code tit. 86, §§ 100.3500(a)(3), 100.3500(b)(1) Arizona & Illinois
• Requires partnership level determination. In Alabama, gain from the sale of partnership assets was not business income to the corporate partners because such sales were not in the regular course of the partnership’s trade or business. Lanzi v. Ala. Dep’t of Rev. (Ala. Civ. App. 2006)
Alabama
59
Business / Nonbusiness Example
• Net Income: $1,000,000
• Dividends: $500,000
• Retail: $500,000
Corporation A
• Limited Partner
• 40% Profits Interest / 40% Capital Interest
• Distributive Share: $400,000
• Business: Investment
Corporation A’s State Tax Return:
1. Assume retail is business income/apportionable
2. Assume dividends are nonbusiness income
allocable outside of state
4. Non-Unitary (LP/no control, 40% capital)
5. $150,000 state sourced income
• Retail: $150,000 ($200,000 x 75% appt)
• Dividends: $0 ($200,000 x 0%)
Sourcing may vary depending upon domicile rule!
A
PTE
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#4 – Special Issues
What problems exist with tiered partnerships?
Timing Issues / Withholding Regimes / Composite Returns
Do the same sourcing rules apply if the partnership has
individual partners instead of corporate?
Some states adopt the corporate apportionment rules for determining
sourcing of nonresident partnership income (e.g., MA)
For those states that still apply individual income sourcing rules, many of
the sourcing guidance remains vague and archaic (e.g., NYS)
Differences may include whether the sale is treated as a sale of an
intangible or sale of tangible assets, and whether gain is sourced to situs
of partnership
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Sale of Partnership Interest
Corporate seller
If business income, generally treated as an intangible source as sale other than
sale of TPP (i.e., costs of performance, possible “throw-out,” etc.)
Some exceptions (such as based on location of the payor)
If non-business income, generally source to commercial domicile
Individual seller
Generally source to resident state
Emerging trend: sourcing based on location of the underlying
PTE’s assets (in theory, only should apply if nonbusiness
income)
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Sale of Partnership Interest Gain or loss on the sale of a partnership interest is allocable to this state in the
ratio of the original cost of partnership tangible property in the state to the
original cost of partnership tangible property everywhere, determined at the
time of the sale.
In the event that more than 50 percent of the value of partnership’s assets
consist of intangibles, gain or loss from the sale of the partnership interest is
allocated to this state in accordance with the sales factor of the partnership for
its first full tax period immediately preceding the tax period of the partnership
during which the partnership interest was sold. • California (Cal. Revenue and Tax Code § 25125)
• Hawaii (Hi. Rev. Stat. § 235-6)
• Maine (Me. Rev. Stat. Title 36, Part 8, Chapter 807 §5142)
• Minnesota (Minn. Stat. §290.17)
• North Dakota (N.D. Cen. Code §57-38.1-17.1)
• Oregon (Ore. Rev. Stat. § 314.635)
• Oklahoma (OK Stat. Title 68, Section 2358)-Publicly-traded partnerships only (and other modifications)
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Sale of Partnership Interest
Use of current year apportionment factor to allocate
gain
Idaho (Id. Stat. Title 63, §3026A)
Montana (Mt. Code Ann. §15-30-2101) – PTP only
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Compliance Headaches/
Withholding Requirements
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Key Issues:
The obligation of nonresident partners to file returns and pay
taxes in every state where a partnership does business creates
an administrative nightmare for both state tax authorities,
PTE management and partners
Must a nonresident partner file returns in every state where a
PTE does business?
What method is required/optional – nonresident filing,
withholding regime or composite filing?
Compliance / Administrative Issues
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Data/Record-Keeping Items
• Partner Data
• Demographics, Partnership Agreements
• State Apportionment
• State Modifications
• State-specific data (credits,
• State Footnotes
• Exemptions/Waivers
• State K-1 by partner and summary
• State WH by Partner and summary
• Supplemental Info.
Data Points Requiring Documentation/Workpapers
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Understanding required items and partners’ needs - Good and appropriate
communication is critical!
What are general and different limited partners (PTEs, Corps, individuals)
information needs?
UBTI footnotes for tax-exempt entities.
Too much information with incomplete explanation can cause confusion and lots
of phone calls/e-mails seeking clarification.
Should provide partners with all information necessary for them to complete
their tax returns accurately
State K-1s, disclosures, and apportionment schedules
Some states may impose a filing requirement if the PTE has a partner that’s
a resident of a certain state (e.g., NY resident partner filing requirement)
Substantial time commitment
Recordkeeping and Data Management
State Disclosures Attached to Federal K-1
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California Cal. Rev & Tax. Cd. §§ 18633-18633.5 Similar to federal reporting requirements (IRC Regulation § 1.6031(c)-1T)
Any person who holds an LLC/partnership interest as a nominee for
another person shall do both of the following:
Furnish to the LLC/partnership, in the manner prescribed by the Franchise Tax Board, the
name, address, and taxpayer identification number of that person, and any other
information for that taxable year as the Franchise Tax Board may prescribe by forms and
instructions.
Furnish to that other person, in the manner prescribed by the Franchise Tax Board, the
information provided (K-1 information) by that entity under subdivision (b).
The provisions of Section 6031(d) of the Internal Revenue Code, relating to the separate
statement of items of unrelated business taxable income, shall apply.
Recordkeeping and Data Management
Nominee Reporting – State Requirements
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Recordkeeping and Data Management
Nominee Reporting - State Requirements
Potential Penalties for Noncompliance – California
Failure to File: 5% per month (capped at 25%) of tax due
Failure to Provide Information: 5% per month (capped at 25%)
of unpaid tax
Failure to Comply with Filing Requirement-Per Partner
Penalties
Aiding and Abetting Understatement of Tax Liability: $10,000 if
liability relates to a corporation
Other??-Was withholding required? Preparer?
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Considerations For Preparers of Returns What information to pass through to partners/investors?
Reporting of factor data to partners has the potential to create confusion unless
accompanied by an explanation
Unitary determination must be made at partner level (or jointly with partnership –
In Practice?)
What do tiered partnerships do in practice?
Does characterization of receipts of the partnership flow through to the partners?
Michigan – RAB 2015-5 states that receipts that flow through from the partnership that
are not “taxed” at the entity level (because they are protected by P. L. 86-272) are not
protected at the corporate partner level – Flow through receipts are from an investment,
and not from the sale of tangible property
What percentages to use for performance fee allocations to G.P.s?
Any impact of proposed regs. under IRC §707(a)(2)(A) (7/23/15) ?
Treats certain partnership distributions as disguised payments for services
Significant entrepreneurial risk requirement
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Considerations for Preparers of Returns Market based sourcing rules for intangibles and services
Lack of uniformity
California
Attach lower tier state K-1s to state partnership return when reporting
lower tier modifications or withholding (e.g. Illinois).
New York City Unincorporated Business Tax (“UBT”)
4% on unincorporated businesses (e.g. partnerships)
Disallowed deduction for payments to partners including amounts paid to partners
of pass-through partner who are employees of a different corporate partner.
Pennsylvania
Required apportionment data depending on partner type:
Single factor for corporations
Three factor (equally weighted) for others
Corporate partner uses reported factors from LLCs to compute income tax but
not capital stock/foreign franchise tax
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General Rule: withholding at the source is generally required
for PTEs with nonresident partners.
Typically pay at the highest individual or corporate tax rate (multiplied
by the owner’s distributive share of income attributable to the state)
Typical Exemptions:
Partner provides an exemption certificate certifying it will file/pay tax
individually
Partner is tax-exempt
Partner files as part of a composite return
PTE is a specialized entity (e.g., investment partnership)
Partner is not a nonresident
Withholding Regimes
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Some states have threshold based on income or tax
May be applied to the entity or to a specific owner
Ex. MI- Requires PTEs with Michigan-sourced business income of over
$200,000 to withhold on behalf of owners that are PTEs or
corporations
Other states thresholds very low
Some rates impose rate differentials that become complex
with tiered structures
Lower tier may have to look to upper tier
Ex. MI- requires withholding for both PTE and corporate owners at the
full 6% corporate. If the PTE knows the ultimate owner of the upper-tier
PTE is a non-resident individual, it may instead withhold at the individual
rate, currently 4.25%.
Withholding Challenges
74
In some states, withholding may not be compulsory
May depend on type of owner, i.e. trust, corproration
May depend on type of PTE
May exempt certain type of entities
Sometimes voluntary at option of PTE and/or owners
Also it may make sense to withhold
May eliminate need to disclose taxpayer sensitive information. .
Withholding Challenges
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Some states allow owners to explicitly elect out of
withholding.
Waiver usually required
May be perpetual or required to be renewed
Keep part of books and records
May need to provide to state
Why elect not to withhold?
Owner has losses in state and no tax will be due
Owner already making estimated tax payments
Prefer to file composite return
Withholding Elections
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Under-report which results in penalties
Based on difference in tax rates between PTE and owner
Tiered Entities- special risks
Withholding may be required by all levels and then there are duplicative
payments
In this situation may want to elect out.
Run higher risk of under-reporting
Attributable to differences in apportionment methodologies between
the business and the owner
Withholding Risks
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Timing issues with estimated tax payments
Often quarterly payments but seasonal business.
Under-report which results in penalties
Based on difference in tax rates between PTE and owner
Tiered Entities- special risks
Withholding may be required by all levels and then there are duplicative
payments
In this situation may want to elect out.
Run higher risk of under-reporting
Attributable to differences in apportionment methodologies between
the business and the owner
Withholding Risks
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Conflict between state reporting requirements and legal
requirements for the PTE
Ex. S corporations
Distributions made to owners must be made on a basis proportionate
to ownership, otherwise the S-corporation runs the risk of inadvertent
termination of its S-election under 2 scenarios:
Owners are residents of multiple states and participation in
withholding is limited to non-residents.. Disproportionate
distributions can result in termination of the S-corporation election.
When the PTE is owned by different types of entities under different
withholding regime.
Withholding Risks
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Typical Conditions:
Requirement of an election/consent to participate is common (some
require consent to be submitted, some require it to be executed and
available but not filed, some require an annual filing)
Limitation of composite returns to individual partners (no corporate or
PTE partners but some allow trust members to participate)
Preclusion of composite returns if the partner has in-state income from
other sources
Agreement that PTE is authorized to resolve any audit/pay deficiency
Composite Regimes
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Why Is It a Nightmare?
Lack of uniformity among withholding/composite regimes. Variations
include:
Composite return wherein nonresident consents to taxation
Nonresident withholding required
Estimated tax payments are required
Withholding done but PTE remains contingently liable
Thresholds of minimum distributions vary
Lack of clear guidance and forms within each state
Compliance software is often outdated
Communication/documentation to/from partners not always timely
Difficulties exist in how to account/report refunds and audit issues to
partners
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Why Is It a Nightmare?
Complexities with multi-tiered structures as outlined herein
PTE funding issues should be established for partner liabilities
Transferee liability/management after PTE ceases operations
Partners not subject to withholding or composite return must typically
agree to submit to the jurisdiction of the state and agree to pay tax on the
owner’s distributive share of PTE income
Be careful – do you want to submit to the jurisdiction of the state? Do you have a
choice?
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Take-Aways
83
SALT Department Tools
Develop a “due diligence” checklist for all PTEs
Establish multistate matrix addressing:
Significant jurisdictional/nexus rules
State method of dividing the tax base
Specialized issues (credits, throwback, etc.)
Required forms (withholding, etc.)
Specialized entity exemptions
Confer with business development / legal teams on
proper terms to include in entity agreements (reporting
requirements, deadlines, information management, audit
management)
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