Composite Returns and Nonresident Withholding for Pass-Through Entities: Navigating the Multistate Complexities

Transcription

1 Composite Returns and Nonresident Withholding for Pass-Through Entities: Navigating the Multistate Complexities Determining Whether to File Composite Returns, Dealing With Withholding Requirements FOR LIVE PROGRAM ONLY TUESDAY, MAY 2, 2017, 1:00-2:50 pm Eastern IMPORTANT INFORMATION FOR THE LIVE PROGRAM This program is approved for 2 CPE credit hours. To earn credit you must: Participate in the program on your own computer connection (no sharing) if you need to register additional people, please call customer service at x10 (or x10). Strafford accepts American Express, Visa, MasterCard, Discover. Listen on-line via your computer speakers. Respond to five prompts during the program plus a single verification code. You will have to write down only the final verification code on the attestation form, which will be ed to registered attendees. To earn full credit, you must remain connected for the entire program. WHO TO CONTACT DURING THE LIVE EVENT For Additional Registrations: -Call Strafford Customer Service x10 (or x10) For Assistance During the Live Program: -On the web, use the chat box at the bottom left of the screen If you get disconnected during the program, you can simply log in using your original instructions and PIN.

2 Tips for Optimal Quality FOR LIVE PROGRAM ONLY Sound Quality When listening via your computer speakers, please note that the quality of your sound will vary depending on the speed and quality of your internet connection. If the sound quality is not satisfactory, please immediately so we can address the problem.

3 Composite Returns and Nonresident Withholding for Pass-Through Entities May 2, 2017 Jeffrey K. Schuetz, CMI, Partner RubinBrown, St. Louis JoAnna Fu Simek, Director BKD, Oakbrook Terrace, Ill.

4 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 PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we 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.

5 Overview Landscape of Non-resident State Tax Enforcement Measures Withholding Overview Composite Overview Election Mechanics Election Strategies Reporting & Planning Issues Taxation of Disposition of Interests Closing 5

6 Who needs to know? Flow-through entities States with nexus States with apportionment 6

7 LLCs, LLPs, LPs, and S-corporations Default treatment -- flow-through entity All items of income and deduction being reported by the owners The entity itself, generally, pays no federal income tax Disregarded entities LLCs with only one owner (SMLLCs) Corporations making a Qualified Subchapter S-Election (Qsss or Qsub) Under the federal "check-the-box" rules unincorporated entities can make an election to be classified for income tax purposes as: If two or more owners: a corporation or a partnership If a single owner: a corporation or a disregarded entity 7

8 Majority of states follow the federal "checkthe-box" treatment of partnerships and LLCs for state income tax entity-classification purposes Partnership or LLC may be subject to state taxes or fees on its income or receipts Many states impose franchise, net worth, minimum fees, or similar entity-level taxes Many states also impose a built-in-gains tax if a federal built-in-gains tax is due (S-corporations) Taxes may be dependent on the type of owner 8

9 Does not follow federal S-Corporation election Complete non-conformity - No S-election allowed (e.g., DC, TN, TX) Separate state-specific election required (e.g., AR, NJ, NY) Partial conformity (e.g., LA) 9

10 Does not Treat Entities as Disregarded Follows Q-sub election (Qsss) to treat entity as disregarded Single Member LLC (SMLLC) treated as disregarded Complete non-conformity (e.g., DC, LA, PA, TN, TX) Partial conformity--some degree of return may be required (e.g., CA, NJ, RI) Separate state-specific election required (e.g., NY) 10

11 Can a state assert nexus over an entity By virtue of its partner/member doing business By virtue of registration with SOS Can a state assert nexus over partner/member By virtue of entity doing business Does it depend on type of interest heldmanagement or non-management, general v. limited liability interest 11

12 Physical Presence Affiliate Nexus Agency Nexus Click-Through Nexus Economic Nexus 12

13 Who can apportion? Businesses doing business in only one state cannot apportion Must be doing business in multiple states, AND Must be filing returns in those state, unless a state does not require a return or impose a tax Applies one or more factors to determine how much income is attributable to the state Typically, property, payroll, and sales factors are weighted 13

14 Sales Factor Increasing weight and dominance May or may not include proceeds from sale of assets or business units 14

15 Most states require non-resident withholding on pass-through entity owners Requirements subject to numerous exemptions and exceptions Area of frequent change 15

16 States generally aggressively pursue partnerships for failure to comply with withholding rules Not always easy to locate forms required to be filed by pass-through entities 16

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18 Auto-Generated Notices Arbitrary assessments or estimates assessments Encumbers the taxpayer to prove the state wrong 18

19 Nexus Questionnaires Seemingly innocuous questions Multiple requests for tax returns Rely on the advice of a professional Answer cautiously Consider layman terms with tax terms Websites beware! Demands for tax returns 19

20 Easier to target business than owners Enforcement mechanisms May levy assets May forfeit right to transact business Prohibit future right to do business 20

21 Withholding May Be Required for Non-Resident Owners Rate depends on type of owner Individual owners: generally, flat rate or highest applicable rate Corporate owners: generally, applicable corporate rate Corporate owners may be treated as non-residents even if domiciled within the state (IL, NY) Trust owners often exempt (even if grantor trust) May look-through multiple tiers to the ultimate type of owner Over 35 states impose withholding at the source on PTEs and their nonresident owners 21

22 When Not Required de minimis May not be due if income for a specific owner is under a certain threshold May not be due if tax due for a specific owner is under a certain threshold 22

23 State AR, CT, GA, ID, ME, MN, ND, OH, OR, RI, WI $ Income de minimis Limit 1,000 CA 1,500 MO 1,200 NM VT (tax) 23

24 Estimated Payments Due quarterly No consideration for whether a cash distribution is actually made Due when a distribution is made Basis of Withholding Distributive share of income Distributed income (cash or property) Tiered entities may be required to withhold at all each separate level, resulting in duplicative tax payments Owner required to file a state return Withholding payments claimed against tax liability or refunded 24

25 Risks Withholding may be insufficient to cover the amount of tax actually due Attributable to difference in rate of withholding and effective tax rate Attributable to apportionment differences between business entity and owner Recomputation of apportionment and state-sourced income can result in over- and under-withholding in multi-tiered entities 25

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28 Composite Returns A single return filed on behalf of non-resident owners Eliminates need for owners to file a separate return in the state Usually eliminates need for withholding Exception: Wisconsin requires withholding even if a composite return is filed withholding reported as a payment on the composite return May be required by the state (withholding disallowed) 28

29 Number of owners States may not allow composite filing for states with fewer than a certain number of owners (MI 1, NY 10) Eligible Owners Non-resident individuals usually qualified Some states restrict individuals with other sources of income within the state Income may be from other investments (e.g., rental) or other pass-through entities Trusts maybe (Grantor usually ok) May be required to have the same fiscal year end Sometimes business entities may also be included Typically, business entities may not be included on a composite return and must file a separate return 29

30 Elections or Agreements States may require owners to sign composite filing agreements Agreements may be perpetual until revoked in writing or may be required to be renewed every year States requiring composite may allow owners to opt-out of composite filing Agreements may be perpetual until revoked in writing or may be required to be renewed every year 30

31 Differences in LLC/LLP and S-Corp Most states follow same rules for entities States with differences: LA, NC, OK, 31

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33 Elections to Opt-Out State may allow for a waiver Waivers may be perpetual until revoked in writing or annual in nature (requires renewal each year) Signed by owner Typically due with returns (e.g., MT due 45 days prior to return, WI due by Feb 28 for CY filers) 33

34 When to Opt-Out When owner has other investments that generate a loss to offset income When owner has other investments that generate income and is already making estimated payments When owner is already filing a return in the state and is making estimated payments When composite return is preferential When multi-tier entities are all subject to withholding 34

35 Many states require a non-resident owner to fill out certain forms electing to be included Some states require PTE to keep on file Some states require form to be submitted to the state Agreements may be perpetual until revoked in writing or may be required to be renewed each year 35

36 Several states require PTEs to maintain on file a power of attorney form executed by each electing non-resident owner States requiring composite returns may allow owners to opt-out of composite filing 36

37 As a best practice the PTE should communicate with its owners on electing to be included in a composite return Communication early is key in order to not miss state deadlines in filing elections 37

38 Convenience vs. Higher Taxes One return filed instead of multiple returns filed for owners Leads to administrative convenience Composite returns usually assessed at highest graduated rate (if a state has a graduated rate) Leads to higher taxes applied as a flat tax May also forfeit other exemptions and standard deductions Owner may be prohibited from filing a return itself and claiming any refunds Overpayments of composite tax usually refundable to the business, not to the owner 38

39 Cost/benefit analysis required Typically, a single owner will benefit from filing at the individual level instead of composite Consider application of graduated rate and exemptions/deductions Entity with more owners will benefit from the administrative convenience of filing composite returns Administrative Issues Notices shifted to business instead of owners Payment of estimates shifted to business 39

40 Loss Years Losses incurred by an entity flow-through to the owner at the federal level. Composite state return usually not required for loss years May result in loss being forfeited at the state level No carryback provision for composite net operating losses 40

41 States have varying conformance to withholding or composites May require either withholding or composite returns May require both withholding and composite May prohibit either withholding or composite returns May prohibit both withholding or composite returns May treat S-corporations and partnerships differently 41

42 Payment of composite and withholding taxes generally treated as a distribution to nonresident owners Disproportionate Distributions Consider impact of s-corporations, where distributions must be equitable Some shareholders may not have elected to be included in composite return 42

43 Disproportionate Distributions (contd.) Some shareholders may be ineligible to be included in a composite return due residency status, income from other sources, etc Composite taxes may not always be a flat tax rate, different rates may apply due to filing status or income level Generally required to true-up the distributions to make them pro rata 43

44 Consider impact of making a separate state s corporation election Corporate income tax rate vs. individual tax rate Credit for taxes paid to others states on resident individual tax return States may limit ability to claim credit where taxes are imposed on the entity, for example a state that does not follow the federal S corporation election 44

45 Sale of a business with an ownership interest in a pass-through entity Sale of a partnership interest may be subject to approval by the partnership Review partnership agreement 45

46 Gains gain from the sale or disposition of intangible personal property (including a partnership or LLC interest) is allocated to the partner's state of residence or domicile Asset sales - gains generally allocated to the state(s) where the assets were physically located May or may not be includible in sales apportionment factor 46

47 Applies to specific items of income, most commonly: Interest, dividends, royalties, rent, gains from securities, gains from sale of assets Can also apply to certain types of businesses Construction companies Can apply to pass-through income from partnerships or s-corporations Tiered entities Can apply to gains on disposition of interest in a PTE 47

48 Apportionment applies the factors to the business income Typically applicable to business income Most income is considered or assumed to be business income Difficult to provide an item is non-business income Allocation specifically assigns specific types of income to a particular state Typically applicable to non-business income Not all states apply business/non-business principles or apportionment/allocation principles 48

49 Example: Company is an active business and generates $100 of income in California and Oklahoma. It owns a partnership doing business solely in Oklahoma and generates $50 of income. Assume that the company s regular business income apportioned to California and Oklahoma is $40 and $60, respectively. Oklahoma allocates the partnership income solely to OK, so the total Oklahoma taxable income would be: Business Income Apportioned: $60 Non-Business Income Allocated: $50 Total: $110 49

50 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 50

51 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) 51

52 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) 52

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54 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 54

55 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 55

56 Considerations: Allocation or Apportionment rules apply Business or non-business income Inclusion in sales factors How does the gain get sourced State of owner State(s) of business 56

57 Disproportionate Distributions Consider impact for s-corporations, where distributions must be equitable Consider impact for partnerships, where distributions must be in accordance with partnership agreement 57

58 Keeping up with pass-through entity withholding and composite requirements can be a challenge Businesses looking to expand multistate operations should carefully consider all the potential filing obligations 58