Multistate Partnerships: Mastering State Taxation of Corporate Partners

Transcription

1 FOR LIVE PROGRAM ONLY Multistate Partnerships: Mastering State Taxation of Corporate Partners WEDNESDAY, OCTOBER 26, 2016, 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 Multistate Partnerships: Mastering State Taxation of Corporate Partners October 26, 2016 Ned Leiby KPMG LLP JoAnna Simek BKD, LLP Dátus Tomasovich KPMG LLP Jennifer A. Zimmerman Horwood Marcus & Berk

4 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

5 Dated Material THE MATERIAL CONTAINED IN THESE COURSE MATERIALS IS CURRENT AS OF THE DATE PRODUCED. THE MATERIALS HAVE NOT BEEN AND WILL NOT BE UPDATED TO INCORPORATE ANY TECHNICAL CHANGES TO THE CONTENT OR T0 REFLECT ANY MODIFICATIONS TO A TAX SERVICE OFFERED SINCE THE PRODUCTION DATE. YOU ARE RESPONSIBLE FOR VERIFYING WHETHER OR NOT THERE HAVE BEEN ANY TECHNICAL CHANGES SINCE THE PRODUCTION DATE AND WHETHER OR NOT THE FIRM STILL APPROVES ANY TAX SERVICES OFFERED FOR PRESENTATION TO CLIENTS. YOU SHOULD CONSULT WITH WASHINGTON NATIONAL TAX AND RISK MANAGEMENT-TAX AS PART OF YOUR DUE DILIGENCE. 5

6 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. 6

7 STATE TAXATION OF PASS-THROUGH ENTITIES Key Issues and Current Developments 7

8 How We Define Pass-Through Entities 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 ) 8

9 Entity vs. Aggregate Example of Structure & Various Chains of Ownership CORP Limited Partners Shareholders (Foreign & Tax-Exempt) General Partner Blocker Corp (The Fund ) Limited Partnership ( LP ) LLC LLC/LP OP,LP (Operations) 9

10 Brief History of PTEs 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 10

11 Corporation vs. Partnership State Taxation Differences 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 11

12 State-Federal Conformity Issues 12

13 State Conformity Overview 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-thebox rules? #2 - Pass-through Treatment: Does the state s tax law follow the federal tax treatment of income of partnerships and disregarded entities? 13

14 #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

15 #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

16 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

17 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

18 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 Corporate Partner Partner 70% Multistate Business Domiciled in UDITPA State $ Distributive Share = Non-business Income PTE NPH LLC 100% in NH 18

19 Entity vs. Aggregate Compliance, Reporting and Planning Considerations Nexus Business/Nonbusiness Determination Unitary vs Non-unitary Apportionment 19

20 Nexus Issues Affecting Partners 20

21 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

22 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

23 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

24 How Have the Cases Come Out? TAX Non-Resident Limited Partners (NRLP ) NO TAX Borden (IL 2000): NRLP taxable because LP interest is sufficient minimum connection Village SM (NJ 2013): NRLP taxable because LP had in-state presence / connection UTELCOM (LA 2011): NRLP not taxable under state statute Lanzi (AL 2006): NRLP not taxable - under Constitution (akin to stock) BIS (NJ 2011) / Dutton (VA 2007): NRLP with no connections not taxable under Constitution 24

25 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

26 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 (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 A (nexus) Corp B (no nexus) Corp C (nexus) Corp D (no nexus) PTE (nexus) 26

27 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

28 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? Partner (State A) PTE (State B) State B 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) State A PTE (State B) 28

29 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

30 Ancillary Nexus Issue #3 PL Key Issue: PL 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 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 (830 CMR (8)(a)) Does PL apply to the income derived from the PTE? Or does PL apply to the corporate partner as the taxpayer under the corporate income tax? 30

31 Ancillary Nexus Issue #3 PL Example: Arizona Dept. of Rev. v. Central Newspapers (11/3/09): Parent Partners 13.5% Ponderay Partners = no AZ nexus; Parent has AZ nexus Ponderay = AZ nexus but protected by 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 ? Holding: AZ may include Ponderay s sales in the Partners sales factor numerator because the taxpayer is the Parent and its activities exceeded does not make certain income tax-exempt it prevents a state from exercising taxing jurisdiction over a corporate partner. 31

32 Division of the Tax Base - Apportionment 32

33 Central Tax Base Issue 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 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

34 #1 Partner (Unitary) Level Method ( Flow-Up / Aggregate / Combined / Unitary ) 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 (d) flow-up if unitary CA: Cal. Code Regs. Tit. 18, s flow-up if unitary MA: 830 CMR flow-up if engaged in related business activities Others (e.g., FL) do not. Constitutionally suspect? Consider the impact on tax base and apportionment! 34

35 Partner Level (Unitary) Example A Corporation A General partner active management 60% Profits Interest / 80% Capital Interest Distributive Share: $600,000 Same line of business as PTE (retail) PTE Retail 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 35

36 Entity vs. Aggregate Calculation of Apportionment Factor 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. 36

37 Entity vs. Aggregate California-Sample Reporting of Apportionment Data to Partner 37

38 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, (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, (c). 38

39 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

40 Entity vs. Aggregate Data Gathering Line 1, 2, 3 are net income. For factor-flowup purposes, these numbers are irrelevant. Note: P&L % may be different than capital % 40

41 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

42 Entity vs. Aggregate Data Gathering Make special note of items of foreign income flowing through as this may impact apportionment. Make special note of items of foreign income flowing through as this may impact apportionment. Foreign Gross Income (Line 16f) should be noted 42

43 #2 Partnership Level (Non-Unitary) Method ( Separate Accounting / Allocation / Non-Unitary ) 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 (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. 43

44 #2 Partnership Level (Non-Unitary) Method ( Separate Accounting / Allocation / Non-Unitary ) 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 instate 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 44

45 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

46 Partnership Level (Non-Unitary) Example A Corporation A Limited Partner (no active management) 40% Profits Interest / 40% Capital Interest Distributive Share: $400,000 Business line different from PTE PTE Net Income: $1,000,000 Business: Retail Apportionment = 75% 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 46

47 Non-unitary Partnership Income Reporting California Example Non-unitary Non-unitary Partnership partnership Income Removed income from removed base income from tax subject base to apportionment. and not subject to apportionment by corporate partner on Line

48 Non-unitary Partnership Income Reporting California Example Allocate CA sourced amount directly on line 28 (after apportionment) 48

49 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

50 #3 Business / Nonbusiness Issues 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? 50

51 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

52 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

53 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 54

55 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

56 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

57 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

58 #3 Business / Nonbusiness Issues 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? 58

59 Entity vs. Aggregate Business/Nonbusiness Determination For corporate partners is the business/nonbusiness income determination made at the partnership level or partner level? Majority of states have not addressed Arizona & Illinois Requires partner level determination Arizona Corporation Tax Ruling No 94-2 (4/4/1994) Illinois Admin. Code tit. 86, (a)(3), (b)(1) Alabama 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) 59

60 Business / Nonbusiness Example PTE A 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! 60

61 #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 61

62 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) 62

63 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 ) Maine (Me. Rev. Stat. Title 36, Part 8, Chapter ) Minnesota (Minn. Stat ) North Dakota (N.D. Cen. Code ) Oregon (Ore. Rev. Stat ) Oklahoma (OK Stat. Title 68, Section 2358)-Publicly-traded partnerships only (and other modifications) 63

64 Sale of Partnership Interest Use of current year apportionment factor to allocate gain Idaho (Id. Stat. Title 63, 3026A) Montana (Mt. Code Ann ) PTP only 64

65 Compliance Headaches/ Withholding Requirements 65

66 Compliance / Administrative Issues 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? 66

67 Data/Record-Keeping Items Data Points Requiring Documentation/Workpapers 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. 67

68 Recordkeeping and Data Management State Disclosures Attached to Federal K-1 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/ s 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 68

69 Recordkeeping and Data Management Nominee Reporting State Requirements California Cal. Rev & Tax. Cd Similar to federal reporting requirements (IRC Regulation (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. 69

70 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? 70

71 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 states that receipts that flow through from the partnership that are not taxed at the entity level (because they are protected by P. L ) 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 71

72 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 72

73 Withholding Regimes 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 73

74 Withholding Challenges 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%. 74

75 Withholding Challenges 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. 75

76 Withholding Elections 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 76

77 Withholding Risks 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 77

78 Withholding Risks 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 78

79 Withholding Risks 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. 79

80 Composite Regimes 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 80

81 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 81

82 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? 82

83 Take-Aways 83

84 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) 84