Arkansas—State S election required

The Department of Finance and Administration reminds taxpayers that qualifying corporations may elect to be treated as Arkansas Small Business Corporations by filing Form AR 1103 with the Corporate Tax Section. The Arkansas election may only be made if a valid S election has been made for federal income tax purposes for the same tax year and a copy of the federal Notice of Acceptance as an S corporation has been submitted. All shareholders in the corporation on the later of the first day of the corporation’s tax year or the day the Arkansas S-Corporation election is made must consent to the election. Arkansas State Revenue Tax Quarterly No. 2 (Apr. 1, 2013).

Observation: Arkansas is one of a handful of states that requires a separate state S election to be filed; otherwise, the entity will be considered an S corporation for federal income tax purposes but a C corporation for state income tax purposes—a trap for the unwary. Other examples of states that require a separate state S election include Mississippi, New York, and New Jersey. Separately, Ohio requires that an S corporation file a notice of the S election with the Ohio Tax Commissioner between the first day of January and the thirty-first day of March every year for which the election is in effect. See Ohio Rev. Code Ann. § 5733.09(B). In Georgia, an S election is only valid for income tax purposes if all shareholders are subject to Georgia income tax or if all nonresident shareholders pay Georgia income tax on their portion of S corporation income. See Ga. Code Ann. § 48-7-21(b)(7)(B). An S corporation must file a consent form for each nonresident shareholder; failure to do so negates Georgia's recognition of the federal S election.

Kansas—S corporations with wholly owned subsidiaries subject to Kansas privilege tax not required to add back certain losses

The Kansas Department of Revenue recently issued a notice to taxpayers regarding changes to the state’s statute dealing with addition and subtraction modifications to federal income for state income tax purposes. During the 2012 legislative session, the Kansas legislature passed HB 2117, which modified the adjustments statute (Kan. Stat. Ann. § 79-32, 117). Kan. Stat. Ann. § 79-32, 117 was further amended during the 2013 legislative session. As a result of the new amendment, S corporations with wholly owned subsidiaries subject to the Kansas privilege tax will not be subject to the requirement in Kan. Stat. Ann. § 79-32, 117(xix) to add back losses reported from Schedule E and on Line 17 of the taxpayer’s federal Form 1040 income tax return. Kansas Dep’t of Revenue, Notice 13-04 Kansas Privilege Tax – Losses (May 5, 2013).

Minnesota—Law does not recognize passive activity deduction for investors in S corporations

The Minnesota Supreme Court held that state law does not recognize a separate “passive activity deduction” for investors in an S corporation. The taxpayers, who were investors in a Minnesota S corporation, thus were not entitled to a deduction for carryover of passive activity losses incurred by the corporation. Instead the taxpayers were entitled to a carryover NOL deduction on their 2007 Minnesota individual income tax return, the amount they claimed as an NOL on their federal income tax return. John Billion, et al. v. Comm’r of Revenue, Minn. S. Ct., Dkt. No. A11-2337 (Mar. 20, 2013).

North Carolina—Shareholders not entitled to claim add-back depreciation deduction on individual returns upon conversion of corporation from C to S status

Individual shareholders of an S corporation were not authorized to claim a deduction on their North Carolina personal income tax returns for additional first-year depreciation previously added back (not deductible) by a C corporation on its income tax returns. For tax years 2002, 2003, and 2004, two C corporations purchased new equipment. They claimed bonus depreciation on their federal returns. Because they were not entitled to the bonus deduction for state tax purposes, however, they added back the amount of bonus deduction to their North Carolina corporate tax returns. After doing so, the corporations were entitled under North Carolina law to deduct the amount added back as depreciation over the next five taxable years. However, before they could use the entire balance of their added-back depreciation deduction, they each converted from C corporations to S corporations. As a result, a balance of the deduction remained unused. The taxpayers claimed on their individual state tax returns the balance of the add-back depreciation deduction to which the C corporations were entitled at the time each converted. The court upheld the state’s disallowance of the taxpayer’s use of the remaining balance of added-back depreciation as a deduction on their individual returns. Bodford, et al. v. N.C. Dep’t of Rev., N.C. Super. Ct., Dkt. No. 11 CVS 464 (Apr. 10, 2013).

Co-author - Patrick Smith, Director Baker Tilly Virchow Krause, LLP

Mr. Ely is a partner and Messrs. Thistle and Rhyne are associates with the multistate law firm of Bradley Arant Boult Cummings LLP in its Birmingham, Alabama office. Mr. Ely is Chair of the firm’s State & Local Tax Practice Group. Messrs. Ely, Thistle, and Rhyne co-author a chapter on the state taxation of PTEs in the treatise “Keatinge, Conaway and Ely on Choice of Business Entity” (West). Mr. Smith is the Tax Director at Baker Tilly Virchow Krause, LLP and is head of State & Local Tax Services for the firm’s Chicago office. Mr. Smith is a co-author of “State Taxation of Pass-Through Entities and Their Owners,” a treatise published by Warren Gorham and Lamont/West since 2005. Messrs. Ely and Smith have co-presented on this topic at NYU’s Institute on Federal Taxation, as have Messrs. Thistle and Smith for a webinar hosted by Strafford Publications in early June.