Discussion:Multistate LLC paid other state taxes on behalf of partner.

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Discussion Forum Index --> Advanced Tax Questions --> Multistate LLC paid other state taxes on behalf of partner.


Discussion Forum Index --> Tax Questions --> Multistate LLC paid other state taxes on behalf of partner.

Barbie (talk|edits) said:

25 September 2007
I have a client whose company became an LLC this year and does business in several states, although my client only works in CA. I noticed a supplemental page with his K-1 showing the other states, income, guaranteed payments and taxes paid on his behalf to them. It said that he could not deduct the taxes on his 2006 return but they might be deductible for 2007. He was surprised when I mentioned this to him.

While waiting for other information I needed from him, I calc'd the other states returns and all but one showed that he would get a refund of the taxes that the company had paid (but not withheld) for him. He came back and said that the company had filed a consolidated partnership return to all states other than CA so there was no need to file outside returns.

My expertise does not cover consolidated returns, so I found myself wondering what would happen if he filed individual returns to these other states (we didn't) and requested the refunds due him?

Any comments?

Southparkcpa (talk|edits) said:

25 September 2007
Barbie

Here in NC , I file multi state all the time. So I believe I can help you. But it can be tricky.

1. The taxes senumerated on the K1 are not deductible in 2006 because they were paid (I am guessing but 99 percent certain)in 2007 by the LLC when the returns were filed. Many states require a flat base tax paid by the partnership for the non resident partners. From an accounting perspective it is a distribution to the partner , NOT tax.

2. He didn't say consolidated state return, there is no such thing. He said a "Compsoite" return. Again, a state collects the 4 percent or 6 percent (depends on state)tax as a withholding. Technically , each state requirements are different. For your purposes, the clients risk is greatly mitigated because tax was paid on his behalf. However, many states require the partner to file and you treat the tax as a withholding. That is why it is on the K1.

3. A refund may be appropriate but the problem I have had is that the tax paid is difficult for the state to verify. I have in fact attached the K1, and the state gives the taxpayer NO credit and sends a bill for the full tax and we get into a correspondence war.

Hope this helps.

Matt

Barbie (talk|edits) said:

26 September 2007
Thanks for yur response, Southparkcpa.

I assumed the taxes had been paid in '07, which is why they should be a deduction on that return. There was not a state k-1 for each state other than CA, which confused me. There was just a spread sheet showing the information for each of the other states (AZ, IL, NY, VA) and some footnotes, including the timing of deduction of the state taxes paid to the non-resident states. The numbers were large enough that I din't want to not file a return if required to the other states so I mentioned it to my client. He went back to his company & came back to me with the information about the company filing in other states. It may help to say that his company is a large investment firm with many partners.

KatieJ (talk|edits) said:

26 September 2007
Most states allow the filing of composite nonresident individual income tax returns on behalf of nonresident owners of flowthrough entities (FTEs), which include partners and S corporation shareholders. These are the rules that generally apply to such filings:

· Permission to file a composite return must be granted in advance.

· The FTE must file a return with the state.

· Only individual owners may be included.

· Only owners who agreed to be included, and who have no other income from sources within the state (or whose only other source income is from FTEs that also file CRs) are eligible for inclusion in the CR.

· The FTE must notify the owners of the election to participate in the program. An election to participate is final and irrevocable upon filing of the return. Some states require each owner to attach a signed election to the return. Others require the FTE to obtain a power of attorney from each owner included in the CR.

· The owners and the FTE must agree that the FTE will accept and pay any assessments of additional tax on the CR. The FTE must agree to represent the individual owners in protest, claim for refund, or appeal proceedings, or in court proceedings relating to the CR.

· The FTE must make estimated tax payments on behalf of the nonresident owners included in the CR.

· The FTE must agree to act as withholding agent in the event that any owner (not just one included in the CR) has a final assessment of tax.

· No deductions are allowed other than those necessary to determine each owner's distributive share of FTE income.

· No credits are allowed other than those attributable to FTE activity.

· Tax for each owner included in the return must be paid at the highest marginal rate.

Not all states require all of these conditions, but generally, that is how the system works. If your client was included in composite return filings, he must have been notified of the opportunity and have agreed in writing to do so. Generally you cannot change your mind; the election is irrevocable.

Many states also require the FTE to withhold tax on the distributive shares of nonresident owners who do not elect to be included in a composite return. Payment of the withholding by the FTE may or may not relieve the owner of the requirement to file an individual nonresident return. If a return is filed, the amount withheld by the FTE is allowed as a credit against the self-assessed tax. Often a refund results because the withholding was set at a relatively high rate (maybe the highest marginal rate in the state), but the actual average applicable rate is lower because of the taxpayer's filing status, dependents, income level, etc.

You need to distinguish between states where the LLC filed composite returns that included your client, and states where the LLC made withholding payments on behalf of your client. In the latter states, your client may be required to file a return, and of course must file a return to get a refund of any overwithheld amount.

Most large LLCs and LLPs (accounting firms, law firms, consulting firms, investment firms, etc.) file composite returns with the states on behalf of members who are nonresidents. Members may want to elect out of the composite returns in certain states, particularly California and New York, where filing their own returns may result in significantly lower total tax liability because of graduated rates, particularly when the individual owner has other losses that reduce his total income. The average applicable rate may be calculated with reference to total income.

The information your client received with his K-1 should include all the necessary detail. If it does not, a phone call to the firm's headquarters should get answers to all your questions.

Barbie (talk|edits) said:

26 September 2007
Thank you so much for your response, Katie. This is very helpful information and I have learned a lot today! ~ Barb

(A few consumer questions and the related responses have been moved to Discussion:Out of state LLC Member)

Barbie (talk|edits) said:

8 October 2007
In the case of my client, the note definitely said the taxes could not be deducted in 2006 but they could be a 2007 deduction.

Death&Taxes (talk|edits) said:

8 October 2007
But there should be a credit on his resident state for the taxes paid to other states. Unfortunately, from my experience, many states refuse the transmittal letter from the accounting firm and you are stuck because often the credit is too small to spend hours fighting about.

KatieJ (talk|edits) said:

9 October 2007
I was with major accounting firms for 20 years and involved with partners' tax compliance, and never heard of anybody having a problem getting his or her home state to allow credit for tax paid on the firm's composite return. It may have happened in isolated cases without my hearing about it, but if it had been a big problem I'm sure I'd have been involved.

A copy of the composite return should easily establish the tax amount. Just redact the other partners' names and SSNs.

Death&Taxes (talk|edits) said:

9 October 2007
Ah, but getting a copy of that composite return so that the return can be timely filed can be the hangup. Perhaps it is because most of my returns where problems have arisen have been Pennsylvania, a state with archaic policies on claiming credits in other state [submit a signed copy of the other state's return......even when the return is efiled]. Delaware has similar rules.

KatieJ (talk|edits) said:

10 October 2007
Sounds like one of those issues where the state is clearly in the wrong and needs to change its policies -- but taxpayer by taxpayer, there is never enough tax involved to justify the cost of taking them to the mat.

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