LLCs and LLPs: Navigating Variable State Tax Treatment Responding to - - PowerPoint PPT Presentation

LLCs and LLPs: Navigating Variable State Tax Treatment

Responding to Latest Changes in LLC Taxation, Non-Resident Withholding, Entity Level Tax, Etc.

THURSDAY, JUNE 13, 2013, 1:00-2:50 pm Eastern

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LLCs and LLPs: Navigating Variable State Tax Treatment Seminar

Patrick Smith, Baker Tilly June 13, 2013 Carolyn Joy Lee, Jones Day cjlee@jonesday.com William T . Thistle II, Bradley Arant Boult Cummings wthistle@babc.com patrick.smith@bakertilly.com

Today’s Program

State Conformity To Federal Pass-Through Treatment [Will Thistle II] Nexus Implications [Carolyn Joy Lee and Will Thistle II] Apportionment Issues [Carolyn Joy Lee and Will Thistle II] Trends In Information Reporting [Patrick Smith] PTE Withholding [Patrick Smith] Entity-Level Taxes [Patrick Smith] Slide 7 – Slide 17 Slide 41 – Slide 44 Slide 29 - Slide 40 Slide 45 – Slide 50 Slide 51 – Slide 55 Slide 18 – Slide 28

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 CONFORMITY TO FEDERAL PASS-THROUGH TREATMENT

Will Thistle II, Bradley Arant Boult Cummings

State Conformity (Or Not) To Federal Treatment of Pass-Through Entities

• Treas. Reg. §§301.7701-1 to -3

– Starting point for any state tax discussion on pass-through entities (PTEs) – Check-the-box (CTB) regulations (eff. 1997)

• U.S. domestic unincorporated entity can elect its tax status,

for federal income tax purposes. – Defaults for U.S. entities (automatic):

• Single member 

Disregarded entity (DRE)

• Multiple members  Partnership

8

State Conformity (Or Not) To Federal Treatment Of Pass-Through Entities (Cont.)

• States are sovereign; they can set their own rules.
• Thankfully, state legislatures quickly acted to conform.

– 25 states conformed in 1997. – Today, the vast majority of states conform (see charts included with Reference Materials for this program).

• But … there are exceptions.

9

State Conformity (Or Not) To Federal Treatment Of Pass-Through Entities (Cont.)

• While conformity seems relatively straightforward …

– It still leaves questions unanswered today.

• How the states conformed :

– DOR issued bulletins on conformity, or – Legislatures enacted specific conformity statutes.

10

State Conformity (Or Not) To Federal Treatment Of Pass-Through Entities (Cont.)

• Some states …

– Only addressed LLCs,

• And forgot about other PTEs (i.e., partnerships and/or

business trusts). – Most say CTB only applies to income tax.

• So, DRE for income tax, but NOT for net worth or sales/use,
• etc. taxes
• Minority say CTB applies to many (perhaps ALL?) taxes.

– Missouri -- Alabama

• - Wisconsin

11

State Conformity (Or Not) To Federal Treatment Of Pass-Through Entities (Cont.)

• A few examples of non-conformity:

– Colorado

• Corporate income tax – disregard single-member LLC

(SMLLC) and impose corporate income tax on non-resident member – District of Columbia

• Follows CTB for corporate income tax but still imposes

―unincorporated business tax‖ (UBT) on partnerships and LLCs not treated as corporations

• But, rates are the same …

– Corp. rate = 9.975% – UBT rate = 9.975%

12

State Conformity (Or Not) To Federal Treatment Of Pass-Through Entities (Cont.)

• Interesting examples of non-conformity

– Louisiana

• CTB does not govern classification of LLCs, for Louisiana

franchise (net worth) tax purposes. – Michigan

• A long and tortured history

– First SBT, then MBT, now CIT – Kmart case – Three separate tax bulletins – NOW – MBT repealed by new CIT » (But, be careful if you elected to remain in the MBT)

13

State Conformity (Or Not) To Federal Treatment Of Pass-Through Entities (Cont.)

• Additional examples of non-conformity

– Pennsylvania

• Income tax - Follows CTB
• Capital stock/foreign franchise tax

– LPs exempt – LLCs taxable

• Can create some terrible results

14

State Conformity (Or Not) To Federal Treatment Of Pass-Through Entities (Cont.)

• More examples of non-conformity

– Tennessee

• Follows CTB, BUT …
• Only SMLLCs that are federal DREs AND have a corporation
• r a business trust as their sole member are disregarded, for

Tennessee excise tax purposes. – Tax rates » Excise tax (net income) = 6.5% » Franchise tax (net worth) = 0.25%

15

State Conformity (Or Not) To Federal Treatment Of Pass-Through Entities (Cont.)

• Major example of non-conformity

– Texas

• Franchise tax on ―taxable margins‖ (2009)
• Most pass-through entities are now taxable.

– Except … » General partnerships owned entirely by natural persons, » Certain passive investment partnerships » Special rule for REITs, and » Certain family limited partnerships. – Combined reporting – Recent constitutional challenges (Allcat, Nestle’)

16

Slide Intentionally Left Blank

NEXUS IMPLICATIONS

Carolyn Joy Lee, Jones Day Will Thistle II, Bradley Arant Boult Cummings

Nexus: Recent Statutory/Regulatory Guidance

Most of the recent statutory and regulatory guidance provides that ownership in an in-state pass-through entity establishes taxable nexus for nonresident partners/members. Examples:

• Michigan: Sec. 206.621(1) (eff. Jan. 1, 2012)
• California: Cal. Rev. & Tax Code Sec. 23101(b) (eff. Jan. 1,

2011)

• Colorado : 1 CCR 201-2:39-22-301.1(2)(v) (eff. April 30, 2010)
• Kentucky: Rev. Stat. Ann. Sec. 141.010(25) (2006)

19

Nexus: Judicial Developments

Similarly, most of the recent court and administrative rulings have concluded that non- resident owners of interests in in-state pass-through entities had taxable nexus in their states. Examples:

• Pennsylvania – Marshall v. Commonwealth (2012)
• Non-resident individual limited partner in Connecticut LP owning a building in

Pittsburgh was taxable on COD income; court only addressed Due Process argument, Commerce Clause position was deemed waived.

• Kentucky – Revenue Cabinet v. Asworth Corp. (2010)
• Court of Appeals held that a corporate limited partner had nexus in KY; Kentucky

Supreme Court denied review but “unpublished” the opinion.

• Iowa – Policy Letter 10240041 (2010)
• Idaho LLC had nexus in Iowa even without physical presence; any non-resident

members receiving more than $1,000 of income from LLC had filing obligations.

• New York – Matter of Shell Gas Gathering Corp. #2 (2010)
• NY Tax Tribunal ruled corporate members of LLC that held general partner interests

in in-state partnership were subject to NY income tax; frighteningly broad rationale.

20

Nexus: Judicial Developments (Cont.)

Bucking the trend:

• New Jersey - BIS LP

, Inc. v. Dir., Div. of Taxation (2012) ― Classic LP tax structure; 2002 legislation provided ownership of any interest in an in-state LP constituted “doing business”. ― Court rejected statute; non-resident 99% corporate limited partner was not unitary with partnership, did not have New Jersey nexus.

• Louisiana - UTELCOM, Inc. and UCOM, Inc. v. Bridges (2011)

― Court of Appeals held that non-resident corporate limited partners were not subject to corporate franchise tax. ― Strictly a statutory construction case; court did not reach constitutional issues or address income tax issues. ― Remember Autozone?

21

Nexus: Judicial Developments (Cont.)

State responses: Some state courts have issued taxpayer-favorable decisions, only to result in their legislatures “fixing” the issue statutorily.

• Alabama - Lanzi v. State Dept. of Rev. (2007)

― Alabama Supreme Court held that ownership in limited partnership did not provide sufficient minimum contacts to impose income tax on a non-resident partner. ― Legislature responded in 2009 by enacting a composite return regime.

• Virginia – Dutton v. Virginia Dept. of Taxation (2007)

― Circuit Court ruled non-resident LLC member was not subject to tax if only contact with state was ownership of LLC interest. ― 2007 Legislature enacted non-resident withholding requirement.

22

Nexus In 2013: Are Worlds About To Collide?

How could a French bus crash and a New Jersey junkyard affect a state’s ability to tax foreign owners of pass- through entities?

23

Nexus In 2013: Are Worlds About To Collide? (Cont.)

• Goodyear Dunlop Tires Operations, S.A. v. Brown (June 27, 2011)

― European Goodyear subsidiaries (Turkey, France, Luxembourg) manufactured tires overseas. The tires allegedly caused a bus accident

• utside Paris, killing two North Carolina teenagers on a soccer vacation.

― Subsidiaries had no direct presence or contact with North Carolina. ― Some of their tires made it to the North Carolina market via affiliates and independent parties. ― Lower courts mixed up the general/specific jurisdiction concepts and relied on a “stream of commerce” concept to assert jurisdiction over foreign subsidiaries. ― 9-0 U.S. Supreme Court reversed; no general personal jurisdiction over foreign actors

24

Nexus In 2013: Are Worlds About To Collide? (Cont.)

• J. McIntyre Machinery, Ltd. v. Nicastro (June 27, 2011)

― English manufacturer of metal-shearing equipment had no presence in New Jersey. ― Sold machinery to independent U.S. distributor (Ohio), which then sold to New Jersey junk yard; machine mauled N.J. worker’s hand. ― “Stream of commerce” principle did not allow plaintiffs to sue foreign manufacturer in New Jersey courts; no personal jurisdiction

• ver foreign actor.

― Did Due Process nexus standard just change, or was it just “clarified”? ― “The principal inquiry in cases of this sort is whether the defendant’s activities manifest an intention to submit to the power of a sovereign.” ― 4/2/3 decision, so long-term implications difficult to predict.

25

Slide Intentionally Left Blank

Nexus In 2013: Are Worlds About To Collide? (Cont.)

• Remember Quill?

― Not just a Commerce Clause case! ― Court specifically recognized that Due Process and Commerce Clauses imposed independent nexus standards. ― Did U.S. Supreme Court just breathe new life into Due Process Clause and perhaps give us a new Quill? ― Are McIntyre and Goodyear (or at least their jurisdictional principles) working their way into state tax cases? ― Red Earth, LLC (2011 Indian Internet tobacco case, U.S. 2d Cir.) ― Scioto (2012 Oklahoma intangibles tax case) ― Conagra (2012 West Virginia intangibles tax case) ― “Due Process and Personal Jurisdiction: Implications for State Taxes”, Denning, 64 State Tax Notes 837 (June 18, 2012) ― “Has the Due Process Clause Gotten Its Groove Back?”, Benton/Calhoun, State Tax Notes, 64 State Tax Notes 721 (June 4, 2012)

27

Nexus In 2013: Are Worlds About To Collide? (Cont.)

Could a private plaintiff haul your corporation before the courts in State X, if your only contact with the jurisdiction was a passive interest in a partnership or LLC operating in State X? ― Could that plaintiff establish personal jurisdiction over the corporation? ― If not, why can State X subject you to taxation?

The Million-Dollar Question:

28

APPORTIONMENT ISSUES

Will Thistle II, Bradley Arant Boult Cummings Carolyn Joy Lee, Jones Day

Apportionment Of Pass-Through Entity Income By Corporate Partners

• Partner level v.

entity level? – 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

P’Ship 2

• Corp. Ptr 2
• Corp. Ptr 1

Do the factors flow up? Or, are the corp. partners stuck with partnership’s factors?

30

Apportionment Of Pass-Through Entity Income By Corporate Partners (Cont.)

• Partner-level approach explained:

– Partners combine their share of PTE’s apportionment factors with their own apportionment factors.

• Referred to as ―flow-through‖ or ―flow-up‖ apportionment
• Also known as ―partner-level‖ apportionment

31

Apportionment Of Pass-Through Entity Income By Corporate Partners (Cont.)

• Partner-level approach explained (Cont.):

– Example

• Assume that a corporate partner has a 60% interest in a
• partnership. The corporate partner would calculate its own

apportionment factor by including 60% of the partnership’s sales, property and payroll (assuming that the state uses a three-factor apportionment formula), but usually only if the partner and the partnership are unitary (or a similar term).

32

Apportionment Of Pass-Through Entity Income By Corporate Partners (Cont.)

• Partnership-level approach explained (Cont.):

– PTE’s income is apportioned to the state using only the PTE’s

• wn apportionment factors.

– Owners of the PTE then allocate their distributive share of post- apportionment income to the appropriate state.

33

Apportionment Of Pass-Through Entity Income By Corporate Partners (Cont.)

• Partnership-level approach explained (Cont.):

– Example

• Corporate partner has a 60% interest in a partnership, which

earns $100 of income.

• If apportionment is calculated at the partnership level, and

the partnership computes a 50% apportionment factor in a state, then the partner would include $30 of partnership income in its tax base in that state (which is 60% of the partnership’s income in the state after apportionment ).

• (I.e., $100 × 50% = $50, and $50 × 60% = $30)

34

Slide Intentionally Left Blank

Apportionment Of Pass-Through Entity Income By Corporate Partners (Cont.)

• California

– See Cal. Code Regs. tit. 18, §25137-1

• If partner are UNITARY with partnership, then partnership’s

factors ―flow through‖ to the partners.

• If partners are NOT unitary with the partnership, then the

factors do not ―flow through‖ to the partners.

• If partners and partnership are NOT unitary, but the income

is considered business income, then partners must apportion partnership income separately from their other business income.

36

Apportionment Of Pass-Through Entity Income By Corporate Partners (Cont.)

• Florida – corporate income tax

– Partnership factors flow through to the corporate partners .

• Apportionment occurs at the partner level.
• (No issue for individuals, because no personal income tax)

37

Apportionment Of Pass-Through Entity Income By Corporate Partners (Cont.)

• Massachusetts

– Partnership factors flow through to corporate partners, if partnership and corporate partners are engaged in ―related business activities.‖ – If they are not engaged in related business activities, corporate partners separately account for partnership income and apportion it using only the partnership’s factors.

• If corporation owns less than 50% of LP, presumed not to be

doing business in MA, and apportionment at partnership level

• Equally weighted, three-factor formula

38

Apportionment Of Pass-Through Entity Income By Corporate Partners (Cont.)

• New Jersey

– Partnership factors flow through to corporate partners, if the partnership and partners are unitary. – Special New Jersey rules of unity for corporate partners and partnerships – If not unitary, apportion partnership income at the partnership level and report distributive share of apportioned taxable income without regard to the partners’ separate apportionment factors – NJ Rev. Stat.§54:10A-15.7(a); NJ Admin. Code tit.18, §18:7- 7.6(g)(3)

39

Apportionment Of Pass-Through Entity Income By Corporate Partners (Cont.)

• Oklahoma

– Partnership factors do not flow through to the corporate partners. – Instead, income is apportioned at the partnership level and allocated to the state by the corporate partners. – Okla. Admin. Code §710:50-17-51(15)(A)

40

INFORMATION REPORTING

Patrick Smith, Baker Tilly

State Information Returns

• 4 out of 5 states require

– Notable exceptions: OH, MI

• Extensions

– May accept Federal 7004 – Generally split between 9/15 & 10/15

• State K-1s
• E-filing

– Depending on facts, efiling/payment may be required: AL, GA, IL, ME, MA, MT, NJ, NYS, TX, WI

42

State Information Returns (Cont.)

• Impact of failure to file (penalties)

– One approach: Tied to withholding

• Indiana: 20% of amount required to be withheld, plus $500

per partner not included in composite

• Pennsylvania: 5% of amount due, per month, up to 50% of

amount due – Different approach: Based on number of partners

• California: $18 per partner, per month, up to12 months
• New York State, Oregon: $50 per partner, per month, up to 5

months – Watch for reportable transactions

43

State Information Returns: Updates

• Alaska – new Form 6900
• Rhode Island – LLCs now file RI-1065; new extension form (RI-7004)
• Montana – if more than 100 partners, e-file
• Pennsylvania – if more than 100 partners, e-file (2013 tax yr)
• Virginia – new consolidated K-1 schedule
• Maine – Form 941P-ME instead of 1065ME/1120S-ME

44

PTE WITHHOLDING

Patrick Smith, Baker Tilly

PTE Withholding: Generally

• 40 states
• States without withholding

– AK, FL, NV, SD, TX, WA, WY – NH, TN – AZ

• Mandatory composite

– AL, CT, IN, LA

46

PTE Withholding

• De minimis threshold
• Quarterly estimates - 40% require

– Example required: CA, MA, MI, NYS, OR – Example not required: CO, CT, GA, IL, NC – Recent activity

• Oregon: Quarterly withholding now required
• Maine: Quarterly payments no longer required
• New Mexico: Quarterly payments no longer required
• E-filing/payment
• Who gets a refund?
• Not an income tax expense

47

Slide Intentionally Left Blank

PTE Withholding: Penalties

• States expect withholding - even if owner files

– Utah

• Petitioner v. Taxpayer Services Div. of Utah Stat Tax Comm’n, Dkt.
• No. 11-2938 (Jun. 1, 2012, released Apr. 10, 2013): Interest due

even for failure to withhold even though nonresident had timely filed/paid. – Delaware

• Visions Unlimited Inc. v. Dir. Of Rev, 1444 (Apr. 8, 2009): Penalties

and interest upheld against S Corp that failed to withhold on behalf

• f non-resident shareholder. Shareholder had timely filed/paid tax.

– Indiana

• Indiana Ltr. of Finding No. 09-0241P (Aug. 1, 2009): Same basic

facts and result as above. ―[T]he issue is not whether the tax was paid, but rather whether the taxpayer complied with Indiana laws governing withholding—a statutory mechanism designed to ensure compliance and ease of enforcement of Indiana tax laws.‖

49

PTE Withholding: Opt-Outs

• Opt-outs (―affidavits‖/―withholding waivers‖)

– Generally available

• Not available: AL, CT, IN, MD, RI, VT

– May vary by owner type

• IL - not available for individuals
• MI - broadened exemption

– May not have to file with state

• MA Form PTE-EX (not filed with state / not required annually)
• IL Form IL-1000-E (not filed with state / not required annually)
• NY IT-2658-E / CT-2658-E (not filed with state / not annual but

expires)

• NJ-1065E (not filed with state but required annually)

– But, many states require

• NC-NPA (by entity) , WI PW-2 (by owner)

50

ENTITY-LEVEL TAXES

Patrick Smith, Baker Tilly

Entity-Level Tax

• Net income

– IL, DC, NH, NYC, TN

• Gross receipts

– CA, KY, OH, TX, WA, WI

• Net worth

– AL, PA, TN, WV

• Annual fee

– CA, CT, MN, NYS, OK, OR, RI, VT

52

Entity-Level Tax (Cont.)

• Key issue: Filing requirements in tiers

Example: Assume LLC 1 operates in CA, CT, IL, NYC, TX and that LLC 2 has no independent operations in these states. Further assume they are taxable as partnerships for federal income tax purposes and are not unitary. What is the filing obligation of LLC 1 & LLC 2?

LLC 1 LLC 2

individual 25% 75%

53

Entity-Level Tax (Cont.)

Example: Assume LLC 1 operates in CA, CT, IL, NYC, TX and that LLC 2 has no independent operations in these states. Further assume they are taxable as partnerships for federal income tax purposes and are not unitary. What is the filing obligation of LLC 1 & LLC 2?

LLC 2 LLC 1

individual CA: Form 568 ($800 annual tax, LLC fee) CT: Form CT 1065; Form OP-424 ($250 annual BET) IL: Form IL-1065 (pays replacement tax on individual’s share) NYS: Form IT-204; Form IT-204-LL (pays filing fee) NYC: NYC IT-204 (pays UBT) TX: Form 05-102, Form 05-158 CA: Form 568 ($800 annual tax) CT: Form CT 1065 IL: Form IL-1065 NYS: Form IT-204; Form IT-204-LL (pays filing fee) NYC: NYC IT-204 (gets credit for UBT paid) 25% 75%

54

Entity-Level Tax (Cont.)

• Other considerations

– Quarterly estimates – E-filing/e-payment – Key deductions (e.g., IL personal services) – Unitary filing (e.g., DC, TX) – ASC 740-10

55