California—State clarifies that single sales factor required for PTEs

California recently issued an administrative release clarifying that PTEs must likewise apportion income using the single sales factor. Proposition 39, which added Cal. Rev. & Tax. Cd. § 25128.7 for taxable years beginning on or after January 1, 2013, requires that business income of an apportioning trade or business (other than an apportioning trade or business described in Cal. Rev. & Tax. Cd. § 25128(b)) is apportioned to the state by multiplying the business income by the sales factor. Cal. Reg. §§ 17951 through 17954 requires such businesses to source such business income in accordance with the provisions of the corporate apportionment rules. Thus, an apportioning trade or business that carries on within and out of California is required to apportion the nonresident’s business income using the single sales factor irrespective of the form of ownership. California FTB Tax News April 2013.

Idaho—Allocation and apportionment of partner’s guaranteed payments

Effective retroactive to January 1, 2013, Idaho limits to $250,000 in a calendar year the amount of guaranteed payments paid by a partnership doing business in Idaho that may be attributed to the state in which the partner performed the services. Amounts paid in excess of $250,000 per year are sourced to Idaho based upon the partnership’s Idaho apportionment factor. The $250,000 limit will be adjusted annually for inflation. This legislation also clarified that all guaranteed payments made to retired partners are sourced to the recipient partner’s state of domicile. L. 2013, H139 (c. 83).

Illinois—“Read our statute”

The Illinois Department of Revenue summarily rejected a taxpayer’s request for alternative apportionment because the alternative method requested appeared to be the default method provided by statute. The taxpayer was a limited partnership based in Texas whose sole source of income was derived from its investment in other partnerships, including partnerships operating in Illinois. In its ruling request, the Texas LP explained that it did not receive apportionment information from its underlying partnership investments that operated in Illinois and therefore was unable to calculate an Illinois sales factor. The Illinois Department of Revenue referred the taxpayer to its statutory provision for the allocation of income derived from non-unitary partnerships, ILCS § 5/305, which provides that the partner allocate its share of Illinois-source income as determined by an apportionment calculation at the underlying partnership level. Illinois Dep’t of Rev. General Information Letters No. IT 13-0001-GIL (Mar. 21, 2013).

Observation: The compliance issue relayed by the taxpayer—lack of timely apportionment data from an underlying PTE investment—is not uncommon. Nevertheless, in its recitation of facts, the taxpayer appeared to describe a context where apportionment data was irrelevant; i.e., it appeared that the Texas LP was non-unitary with the underlying partnerships, in which case the Illinois statute required that the nonresident LP allocate its share of the Illinois-source income as apportioned at the underlying entity level. The Department’s brusque response dodged the thornier question of how a nonresident partner should apportion its distributive share of income in the context in which the partner and partnership are unitary but the underlying partnership fails to timely provide apportionment information.

Michigan—S corporation shareholder not allowed to aggregate apportionment factors

The Michigan Supreme Court held in abeyance an appeal of a Michigan Court of Appeals case, Winget v. Department of Treasury, Mich. Ct. App., Dkt. No. 302190 (Oct. 16, 2012) (unpublished), that had ruled that the sole shareholder of several S corporations could not combine apportionment factors of the various S corporations. Noting that the S corporations were legally separate and distinct business entities with no common ownership at the entity level, the Court had ruled that the S corporations did not form a single business entity and therefore the taxpayer was required to apply a separate apportionment percentage to each S corporation. In its abeyance order, the Court referred to two cases pending on appeal before it, Malpass v. Department of Treasury, 295 Mich. App. 263, 815 N.W.2d 804 (2011), and Wheeler Estate v. Department of Treasury, 297 Mich. App. 411, 825 N.W.2d 588 (2012). The court noted that the decisions in those cases may resolve an issue raised in the present application for leave to appeal. Therefore, the present appeal is to be held in abeyance pending the decisions in those cases. Winget v. Department of Treasury, Mich. Ct. App., Dkt. No. 302190 (Oct. 16, 2012 - unpublished); leave to appeal ordered to be held in abeyance, Mich. S. Ct., Dkt. No. 146218 (Apr. 1, 2013).

Minnesota—LLC not unitary with corporate member

The Supreme Court of Minnesota held that there was insufficient flow of value between the taxpayer and an LLC of which it was a member and inadequate control by one over the other to establish the existence of a unitary business between the taxpayer and the LLC during the period at issue. The taxpayer, a Delaware corporation, provided pharmacy benefit management (“PBM”) services and operated a mail-order pharmacy. The taxpayer and two other PBM services formed an LLC to create an electronic prescription and information routing service to facilitate prescription benefit communications. The court ruled that there was insufficient flow of value between the taxpayer and the LLC to establish a unitary business relationship between the two entities. The evidence showed that the taxpayer and the LLC conducted arm’s length transactions. Moreover, the LLC had its own departments responsible for making its own operational and strategic decisions. During the period at issue, the taxpayer employed no LLC employee; none of the taxpayer’s employees were employed by the LLC; and the two businesses maintained separate human resources personnel, separate legal and accounting departments, separate books and records, separate data processing systems, separate intellectual property ownership, separate purchasing offices, separate office facilities, and separate bank accounts. Express Scripts, Inc. v. Commissioner of Revenue, Minn. Tax Ct., Dkt. No. 8272 R (July 20, 2012).

Virginia—Pass-through income taxable

A recent Virginia ruling concerned a husband and wife who resided outside Virginia and owned a membership interest in an LLC also domiciled outside the state. The husband was also the primary shareholder of VSC, an S corporation based in Virginia that provided financial and retirement services. VSC was the LLC’s only client and paid the LLC fees in exchange for investment and asset management services on behalf of the S corporation’s clients. On its Virginia income tax return, the taxpayers attributed a loss received from the Virginia S corporation to Virginia while attributing income passed up from the out-of-state LLC entirely outside the state. Based on the number of days the taxpayer spent in Virginia and the nature of the business, the Commissioner ruled that the LLC and taxpayer conducted operations in Virginia and therefore had income subject to Virginia income tax. The Department noted that in future years the taxpayer should document the time worked in Virginia and elsewhere. Virginia Public Document Ruling No. 12-219 (Dec. 21, 2012).

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.