California—Continued focus on nonresident withholding
In a 2011 budget document, the California FTB released revenue projections related to nonresident withholding that showed aggressive expected increases in withholding-related receipts: “$8 million in FY 2010/11, increasing to $15 million in FY 2011/12, $16.5 million in FY 2012/13, and ongoing revenue of $18.2 million beginning in FY 2013/14.” In order to ensure this stream of revenue, the FTB requested “funding to increase compliance with nonresident withholding by pursing new outreach, education, and discovery activities.” As part of this process, the FTB recently announced that beginning January 17, 2013, the “Withhold at Source and Compliance Section” (“WSCS”) will automate “Withholding Information Notices” (“WIN”). WSCS administers the nonwage withholding program, which includes real estate, resident, nonresident, and backup withholding. In 2011, WSCS implemented the new automated “Withhold at Source System” (“WASS”) to process withholding forms and payments. Beginning in 2013, WSCS will send WINs to taxpayers that submit FTB Form 592, 592F, or 593, resulting in a discrepancy. If the discrepancy results in an overpayment, the taxpayer should follow the instructions on the WIN to resolve it; if the discrepancy results in a balance due, the FTB will mail a separate bill. Individual taxpayers and estates and trusts will receive a Statement of Tax Due. Business entities will receive a Notice of Tax Due. The taxpayer should follow the instructions on the STD or NTD to make a payment. California FTB Public Service Bulletin No. 13-06 (Jan. 15, 2013).
California—Failure to timely withhold penalty
An LLC doing business in California failed to establish reasonable cause to abate the penalty for failing to timely file. For tax year 2008, the LLC was required to withhold taxes, file “Quarterly Nonresident Withholding Statements” (Form 592) and remit the withheld taxes to the Franchise Tax Board because some of the LLC’s partners were nonresidents of California. The LLC filed Form 592 eleven days past the due date, reporting withholding for 77 nonresident partners for 2008. Penalties were not abated, however, because the LLC failed to (1) substantiate that it timely requested tax information from a withholding agent or take any other steps to determine or estimate the amount of withholding by the applicable deadline; (2) explain why it did not file the Form 592 until approximately three and a half months after it received all the necessary information; and (3) provide evidence supporting its argument that it could not file the Form 592 until after it received the last required Schedule K-1. The LLC’s failure to produce the requested information suggests that the information, if produced, would have been unfavorable to its appeal. Appeal of Cornerstone Real Estate Fund A, LLC, SBE, Case No. 574006 (Oct. 24, 2012, released Feb. 26, 2013) (not to be cited as precedent).
Georgia—Legislation changes withholding frequency
Historically, nonresident withholding has been required monthly for actual distributions and annually for distributive share (i.e., distributions credited but not paid). Effective for tax years beginning on or after January 1, 2012, however, withholding is only required annually on the nonresident member’s share of the taxable income sourced to Georgia—whether or not distributed. Payment is due on or before the due date, without extensions, for filing the income tax return of the entity. HB 965 (O.C.G.A. §§ 48-7-114 and 48-7-129).
Maryland—Tax rate change for nonresident owners
The Maryland Comptroller’s Office updated an administrative release relating to the taxation of PTEs with nonresident members. The release conforms to the increase in the highest individual income tax rate for 2012, resulting in a tax rate imposed on PTEs that is paid on behalf of nonresident individual members for 2012 equal to 7 percent (i.e., the lowest county income tax rate of 1.25 percent plus the highest individual income tax rate of 5.75 percent). Maryland Administrative Release No. 6 (Sept. 1, 2012).
Michigan—Withholding exemption broadened
Michigan recently amended its exemption from flow-through entity withholding. Effective January 1, 2013, a flow-through entity that receives an exemption certificate from a member other than a nonresident individual (previously, more narrowly, from a corporation) is not required to withhold tax on the distributive share of business income of that member. The exemption must certify that the member will pay the required corporate income tax on the distributive share of the business income received from any flow-through entity in which the member has an ownership or beneficial interest. Finally, the law provides that the Michigan Department of Treasury may require the member to file the exemption certificate and provide a copy to the flow-through entity. Previously, the corporation had to file the exemption certificate with the Department and provide a copy to the flow-through entity. L. 2013, S65 (P.A. 15) (effective retroactive to Jan. 1, 2013).
Observation: Most states that impose a withholding requirement on PTEs also provide an opt-out that is available for certain or all of the PTE’s owners. North Carolina’s opt out, for example, is only applicable to partners that are corporations, partnerships, trusts, or estates—not individuals or grantor trusts. Some states require the nonresident owner to sign and file the affidavit with the PTE (e.g., New Jersey, New York), though a few do not (e.g., Iowa, Missouri). Many states require that the PTE file the form with the state (e.g., North Carolina, Wisconsin), though other states do not impose this requirement (e.g., Illinois, New Jersey, New York, Pennsylvania, Ohio).
Michigan—2012 annual flow-through withholding reconciliation
Effective February 19, 2013, Michigan made significant updates and clarifications to its instructions to Form 4918, Annual Flow-Through Withholding Reconciliation Return. These changes—many of which concern apportionment calculations in tiered structures—are noted within the Flow-Through Withholding Booklet (Form 5014). Michigan 2012 Annual Flow-Through Withholding Reconciliation Instruction Updates (Feb. 22, 2013). Note that the state has also released instructions to Form 4918 and Form 4917, Flow-Through Withholding Quarterly Report.
Montana—Withholding form changes
Beginning with the 2012 tax year, Form PT-WH, Montana Income Tax Withheld for a Nonresident Individual, Foreign C Corporation, or Second Tier Pass-Through Entity, has been discontinued. In prior years, a PTE reported the amount of pass-through withholding attributable to each owner on a Form PT-WH and the owner’s Montana Schedule K-1. Now, PTEs will only report each owner’s distributive amount of pass-through withholding on a Montana Schedule K-1.
Additionally, beginning with tax year 2012, PTEs or their owners are required to file Form PT-AGR, Pass-Through Entity Owner Tax Agreement, separately with the Department of Revenue. Form PTAGR is due on or before the due date of the PTE’s return. If Form PT-AGR is filed on time, the PTE does not have to pay tax on behalf of its owners that are nonresidents or foreign C corporations. Beginning with tax year 2012, Form PT-AGR may be filed electronically. The form can also be filed by mail.
Beginning with tax year 2012, PTEs or their owners are required to file the Form PT-AGR separately with the department. Prior to tax year 2012, Form PT-STM, Second-Tier Pass-Through Entity Owner Statement and Waiver Request, was attached to a PTE’s tax return. Form PT-STM is due 45 days before the original due date of the first-tier PTE’s return. When the state receives Form PT-STM, it will notify the first-tier PTE within 30 days regarding the status of the waiver request. If the first-tier PTE receives a waiver, it does not have to pay tax on behalf of a secondtier pass-through owner with the first-tier PTE’s return. Beginning with tax year 2012, Form PTSTM can be filed electronically on Taxpayer Access Point (“TAP”) and can also be filed by mail.
New Mexico—Nonresident owner withholding changes
Retroactive to January 1, 2012, withholding from nonresident owners of a PTE is required annually. Previously (and only briefly), a PTE was required to remit the tax quarterly. The requirement to remit the tax annually was reinstated for tax years beginning on or after January 1, 2012. The entity files and pays the tax due when Form RPD-41367, Annual Withholding of Net Income from a Pass-Through Entity Detail Report, is submitted to the Department.
Additionally, if a PTE has more than 50 owners that receive New Mexico net income, the entity is required to electronically file Form RPD-41367, Annual Withholding of Net Income from a Pass- Through Entity Detail Report, through the Department’s website. If the entity has more than 50 such owners and is unable to file electronically because a hardship exists, the entity may request Department approval to file by paper. The PTE may request approval by filing Form RPD-41350, E-File Exception Request Form. The request must be received by the Department at least 30 days before the taxpayer’s electronic report is due. New Mexico Tax’n and Rev. Dep’t, New Mexico Bulletin, B-200.25 Rev. 9/2012 (Sept. 2012).
North Dakota—Withholding/composite rules modified
Effective for tax years that begin on or after January 1, 2014, North Dakota legislation expands the definition of “pass-through entity” to include grantor trusts and entities similar to PTEs not taxed as entities for federal income tax purposes. Additionally, the definition of “nonresident” will be expanded to include a PTE that does not have its commercial domicile in North Dakota. The definition of “member” will be expanded to include a settlor of a grantor trust or a PTE.
The legislation also provides that a member that is a lower-tier PTE may make an election to be exempt from the withholding requirement. The form must include a statement that the member will file any return and pay any tax required on its distributive share of income from the source PTE and that the member is subject to North Dakota’s jurisdiction for the collection of that tax and any applicable penalty and interest. The Tax Commissioner may revoke the exemption if the source PTE or member fails to comply with those rules. If the exemption is revoked, the source PTE must begin withholding from the member within 60 days of receiving notification of the revocation from the Tax Commissioner. L. 2013, S2104.
Oregon—Nonresident owner withholding required quarterly
Effective January 1, 2013, the Oregon Department of Revenue amended its withholding regulation (Rule § 150-314.781) to provide that a PTE must remit required withholdings to the Department on a quarterly basis. The due dates of these required payments are the 15th day of the 4th, 6th, 9th, and 12th month of the entity’s tax year. For estimated tax payments due on or after January 1, 2013, the entity will submit an annual report. The report is due the last day of the second month following the close of the entity’s tax year.
Utah—Interest waiver request denied related to failure to withhold
The Utah State Tax Commission upheld the imposition of interest against a PTE that failed to withhold income tax on behalf of a nonresident partner who had, nonetheless, pre-paid the amount of tax due to be paid on its behalf. The PTE and its nonresident owner had a different year end (December 15 and June 7, respectively). The PTE argued that it was therefore unable to calculate the amount of withholding due and should not be liable for interest due because the owner had fully prepaid the amount of tax due on its behalf. The Utah State Tax Commission disagreed, citing the state’s withholding penalty/interest waiver provision, which provides for the abatement of penalties and interest if the owner files and pays its share of tax prior to the date on which the underlying PTE would be required to withhold. Despite the prepayments, the Commission adopting a form-over-substance approach and rejected the taxpayer’s argument because the owner had not filed a return and therefore did not meet the technical requirements of the waiver provision. Petitioner v. Taxpayer Services Division of the Utah State Tax Comm’n, Utah State Tax Commission, Dkt. No. 11-2938 (Jun. 1, 2012, released Apr. 10, 2013).
Observation: This decision reflects a growing state trend of upholding penalties and/or interest imposed on a PTE for failure to withhold in contexts where the owner actually has already paid its share of tax due to the state. Other states that have upheld the imposition of penalties/interest even when the nonresident owner paid the amount of tax due include Delaware (Visions Unlimited Inc. v. Dir. Of Rev, 1444 (Apr. 8, 2009)) and Indiana (Indiana Letter of Finding No. 09-0241P (Aug. 1, 2009)), whose decisions also provide an example of the form-oversubstance approach. Consider the language in the Indiana ruling: “[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.”
Utah—PTE withholding changes
Effective January 1, 2013, Utah added estates and trusts to the list of entities defined as a “passthrough entity” that are required to withhold. The legislation also clarified that retirement and pension plans structured as PTEs are exempt from withholding. Finally, the legislation established a de minimis threshold for collecting withholding taxes from trusts if the trust beneficiaries meet some safe harbor standards. Utah S.B. No. 143 (2012 Regular Session).
Additionally, effective February 21, 2013, the Utah State Tax Commission amended its withholding regulation, Utah Admin. Code r. § R865-9I-13. Changes include deleting the provision stating that a PTE is not required to withhold tax on behalf of a PTE taxpayer where the PTE taxpayer is an individual retirement account (“IRA”), as defined under IRC § 408(a), and the income from the PTE is not unrelated business income to the PTE taxpayer. Non-substantive technical changes were also made.
Wisconsin—LLC quarterly withholding required
The Wisconsin Department of Revenue updated its helpful LLC publication and now requires PTEs to make quarterly payments of estimated withholding tax on nonresident owners’ shares of income attributable to Wisconsin. The PTE must make quarterly payments of withholding tax on or before the 15th day of the 3rd, 6th, 9th, and 12th month of the taxable year. Wisconsin Dep’t Rev., Tax Publication No. 119 (Jan. 1, 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.