Advanced Multistate Taxation of Partnerships and Individual Partners Business vs. Nonbusiness Income Characterization, Reconciling Conflicting States Tax Treatments and More WEDNESDAY, JANUARY 27, 2016, 1:00-2:50 pm Eastern IMPORTANT INFORMATION 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 1-800-926-7926 x10 (or 404-881-1141 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 emailed to registered attendees. To earn full credit, you must remain connected for the entire program. • WHO TO CONTACT For Additional Registrations : -Call Strafford Customer Service 1-800-926-7926 x10 (or 404-881-1141 x10) For Assistance During the 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.
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Advanced Multistate Taxation of Partnerships and Individual Partners January 27, 2016 Ned Leiby Jennifer A. Zimmerman Director, Income and Franchise Taxes Attorney Ryan Horwood Marcus & Berk Chartered ned.leiby@ryan.com jzimmerman@hmblaw.com
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.
STATE TAXATION OF PASS-THROUGH ENTITIES Key Issues and Current Developments Jennifer A. Zimmerman Horwood Marcus & Berk Chartered 5
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”) 6
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 7
State-Federal Conformity Issues 8
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 -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”? 9
#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) 10
#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, MI, OH, OK, TN, TX) – Don’t forget local jurisdictions (Phili, 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 11
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 12
Conformity Conflicts “Jurisdictional Mismatches” may occur. Example: – PTE operates solely in NH; 70% Multistate Business corporate partner domiciled in Corporate Partner Domiciled in UDITPA UDITPA state, conducts business in Partner State many states; PTE distributive share is “non - business” income $ Distributive Share = Non-business Income – NH: Applies entity-level tax on PTE 70% (BPT & BET) using water’s edge combination apportionment factors (no business/non-business distinction) NPH PTE – Domicile state: taxes entire 70% LLC share of “nonbusiness” income to 100% in NH the Partner in state of commercial domicile 13
Nexus Issues Affecting Partners 14
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 correct to tax a nonresident limited partner on its 2% distributive share but not a nonresident shareholder on its 2% stock ownership in a corporation? 15
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)) 16
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? 17
How Have the Cases Come Out? NO Non- Resident Limited Partners (NRLP”) TAX TAX Borden Village SM UTELCOM Lanzi (IL 2000): (NJ 2013): (LA 2011): (AL 2006): NRLP taxable NRLP taxable NRLP not NRLP not because LP because LP taxable – taxable - interest is had in-state under state under sufficient presence / statute Constitution “minimum connection (akin to stock) connection” BIS (NJ 2011) / Dutton (VA 2007): NRLP with no connections not taxable – under Constitution 18
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 A Corp B Corp C Corp D (nexus) (no nexus) (nexus) (no nexus) PTE (nexus) 19
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