Nonresident Withholding: Could They Make it Any Easier?

If you or your client operates within a pass-through entity such as a S corporation, partnership or limited liability company, then you know what nonresident withholding is.

In basic terms, "nonresident withholding" is when a state requires a pass-through entity to withhold state income tax (or make a state tax payment) on a nonresident shareholder's pro rata share of the pass-through entity's income sourced to the specific state. In other words, it is a mechanism for states to better ensure that state tax will be paid by nonresident shareholders.

Now, if you or your client operates within a multi-tiered structure of pass-through entities, then nonresident withholding can become a compliance "nightmare" for both you and state taxing authorities. Most states have difficulty tracking nonresident withholding when it passes through multiple layers before it gets to the ultimate taxpayer. Therefore, state tax notices upon state tax notices can become an unwelcome, but familiar friend.

With that said, here are a few tips or questions to ask when dealing with nonresident withholding in multi-tiered structures:

1) Does the state require quarterly nonresident withholding on "actual payments/distributions" or on "allocated income"? To put it simply, some states only require quarterly nonresident withholding if a cash payment is actually made to a shareholder. If states don't require quarterly nonresident withholding, most, if not all states require annual nonresident withholding on "allocated income" whether a distribution is actually paid or not.

2) Is nonresident withholding required to be done for all nonresident shareholders regardless of the type of shareholder? Meaning, is withholding required for C corp, S corp, partnership, LLCs, individual and/or trust shareholders?

3) Does the state allow or have a mechanism for nonresident shareholders to obtain a waiver or exemption from nonresident withholding? Meaning, can a nonresident shareholder provide the pass-through entity or the state with a document to keep the pass-through entity from withholding on its share of the state's source income?

4) Is the nonresident withholding required to be done on a quarterly basis? Or can it be paid one time a year?

5) In a multi-tiered pass-through entity structure, at what level is nonresident withholding required to be done? Meaning, is the lowest entity required to do the withholding or does the state only require the entity before the ultimate taxpayer to do the withholding? This is a key question, because if it is done at the wrong level, it can cause great confusion and an explosion of notices between the state and the taxpayer.

Some of the top "problem states" when dealing with nonresident withholding are: California, Colorado, Indiana, Iowa, and Kansas. These are just a few. As I stated earlier, in a multi-tiered structure, nonresident withholding is a "tracking nightmare" for both the taxpayer and the state. Obviously, it requires meticulous record keeping to get it right.

If you or your client operate within a multi-tiered, multi-state pass-through entity structure, please contact leveragesalt@earthlink.net to help you work through the "maze."

Combined Reporting: Everybody's Doing It

With state budgetary problems, it seems almost every state is considering combined reporting. As stated in a post a few days ago, Wisconsin recently enacted combined reporting. Before Wisconsin, twenty-one states required combined reporting. Some of the other states with recent enactments of combined reporting are Texas, Michigan and New York.

West Virginia enacted combined reporting back in April, 2008 for tax years beginning after 2008. In West Virginia, waters-edge combined reporting is mandated for unitary business groups, unless worldwide unitary combined reporting is required or an election is made to report on that basis. A worldwide unitary combined reporting election is binding for 10 years once it is made. (S.B. 680, Laws 2008)

Massachusetts enacted legislation recently as well, that requires corporations that are engaged in a unitary business to file combined returns. Like West Virginia, Massachusetts allows an election to file on a worldwide basis. If the election is made, it is binding for 10 years. (Ch. 173 (H.B. 4904), Laws 2006, effective July 3, 2008)

Other states have proposals to require taxpayers engaged in a unitary business with one or more other corporations to file a combined report:

* Tennessee (H.B. 1350 / S.B. 502; introduced 2/12/09 and 2/10/09)

* Maryland (S. B. 603, introduced 2/6/09)

* Missouri (S.B. 241, introduced 1/26/09)

* Connecticut (S.B. 807, introduced 2/3/09)

* New Mexico (S.B. 389, assigned to Corporations and Transportation Committee (S), 1/30/09)

States are obviously moving to combined reporting in the hopes of eliminating tax loopholes and raising revenue due to their state budgets. Some of the states listed above have introduced similar bills previously without passage; however, something tells me the bills mentioned above may have a better chance of passing due to the financial condition of each state. Just as businesses are now open to new ways of doing things to survive or "stop the leaking," states may now be open to legislation that perhaps they weren't in the past.

Be on the lookout for more legislative activity among the states as revenues continue to decline.

California Tax Refunds: Still Waiting

The State Controller announced on Thursday, February 19, 2009, that once the budget plan provides the needed cash in the treasury, his office will work around the clock to get delayed payments out the door.

The following is from the California website, which provides some answers to frequently asked questions regarding the delay in refunds.

Frequently Asked Questions

1. Should I wait to file my return?

No. If you have all of the documents and information needed to prepare your return, you may file it any time through April 15 (or October 15, if filed on extension). The refund delay does not affect the return due date or our ability to process returns.

2. When will the refund delay be lifted? (Updated February 20, 2009)

It is anticipated that as soon as the cash problems are solved, the refund delay will be lifted. Check this website for updated information on the status of the delay.

3. Now that the budget is passed, when will my refund be issued? (Updated February 20,
2009)

Even though the budget is enacted, the state must now determine if there is sufficient cash to pay outstanding debts, including tax refunds. Until then, refunds will continue to be delayed.

4. Will you still honor my direct deposit request (DDR) when the delay is lifted?

Yes, your DDR will be honored when the state resumes the payment of refunds.

5. Is it possible that I will be issued an IOU?

If the state’s cash flow problems do not improve, the Controller may need to issue IOUs. If the Controller has to issue IOUs, you will receive a paper IOU warrant, even if you requested a direct deposit of your refund.

6. Are all refunds delayed or just 2008 tax year refunds? (Updated February 20, 2009)

All refunds are delayed, regardless of the tax year they apply to. For example, an approved refund claim for tax year 2006 will be delayed until the state’s cash problems are solved.

7. Am I entitled to receive interest because of the delay?

It depends upon the length of the delay. For individual taxpayers, interest on current year refunds is only paid if your refund is not issued within 45 days after April 15, or the date that your return is filed, whichever is later. If you are entitled to receive interest on a prior year refund, you will receive it when your refund is issued.

8. Can I apply my refund as an estimated payment toward my 2009 taxes?

Yes, if on your 2008 return you request that your refund be applied toward your 2009 taxes, we will apply the amount you designate when we process your return.

9. If I owe for other debts collected by FTB, will my refund be applied toward that debt?

Yes. You will be refunded the difference, if any, once the delay on issuing refunds is lifted.

Copyright © 2007 State of California

California Changes: "Doing Business," Single Sales Factor, Finnigan, Cost-of-Performance Repeal, "Gross Receipts" Definition

California reached a budget deal last week and Governor Arnold Schwarzenegger signed it into law on February 20, 2009.

The budget deal includes several revisions to the corporation franchise and income tax provisions including: the revision of the definition of "doing business," the allowance of taxpayers to elect to use a single sales factor apportionment formula, implementing a statutory definition of "gross receipts" for purposes of the sales factor, the adoption of the Finnigan rule for purposes of the sales apportionment factor, and the repeal of the cost-of-performance sourcing rules for purposes of determining where sales proceeds from intangible property transactions should be sourced. All of these changes begin with the 2011 taxable year.

Other changes were made as well, including a New Jobs Credit beginning with the 2009 taxable year, and a Motion Picture Production Credit beginning with the 2011 taxable year.

For details regarding the changes, please contact your state and local tax professional or leveragesalt@earthlink.net.

Ch. 17 (S.B. 15), Laws 2009, Third Extraordinary Session, effective February 20, 2009, and applicable as noted above; Assembly Floor Analysis of S.B.x3 15, February 15, 2009; Senate Floor Analysis of S.B.x3 15, February 14, 2009; Press Release, Gov. Schwarzenegger's Office, February 19, 2009

California LLCs: Under Attack

If you or your clients are operating as a limited liability company in California, and you are not in compliance, now is the time.

According to an article by Cyndia Zwahlen in the L.A. Times, limited liability companies that have failed to file required forms or pay fees and taxes, face suspension.

You can view the complete article at:
http://www.latimes.com/business/la-fi-smallbiz12-2009jan12,0,4595527.story January 12 2009

Visit latimes.com at http://www.latimes.com/

Economic Recession - Impact on SALT Practices?

I am curious as to how the economic recession is impacting the state and local tax practices of firms, whether they be law firms, accounting firms, the Big 4 or boutique firms. Has business slowed down? Are layoffs occurring? What type of work is the focus now? Has consulting "dried up?"

I am also wondering if some firms will abandon their SALT practices all together. Will they abandon a niche to become more broad in their appeal due to diminishing profits and drops in workload?

I recently read an article by Tom Kane at the legalmarketingblog (http://www.legalmarketingblog.com/marketing-tips-dont-dilute-your-niche-in-a-down-economy.html), that said "Don't Dilute Your Niche in a Down Economy."

He also referenced Sara Holtz and her post “Don’t be tempted to abandon your niche” on her Women Rainmakers bLAWg.

According to Sara, if you broaden your marketing efforts because times are tough, it will hurt you in several ways:

* Diffuses your message
* Spreads your resources thinner, and
* Just creates more competition in the broader marketplace.

It is smarter to stick with your niche strategy, rather than diluting it just because the economy is down.

I agree with both Sara and Tom, and would like to receive comments from state and local tax professionals. What do you think?

BAT Simplification Act Reintroduced in U.S. House

Once again, the U.S. House of Representatives has introduced legislation that would expand the protections of P.L. 86-272 and codify a physical presence nexus standard for business activity taxes. It seems like the Federal Government has introduced this type of legislation on an annual basis during the last few years, but it never goes anywhere. Not sure if it will go anywhere this time.

Nexus standard: The legislation would prohibit a state from imposing a business activity tax (BAT) on any taxpayer, unless the taxpayer has a physical presence in the state for 15 days or more during the year. Presence in a state "to conduct limited or transient business activity" would not establish physical presence. These standards may seem to provide necessary thresholds, but they may not be constitutional if they were to be examined more closely or challenged in court.

P.L. 86-272: The legislation also would extend the protections of P.L. 86-272 to all business activity taxes, not just net income taxes as is currently the case. Furthermore, it would include in protected activity solicitations with respect to any sale or transaction approved and fulfilled outside the state, including transactions involving intangible property and services. Currently, P.L. 86-272 only applies to solicitations for sales of tangible personal property.

Protected activity would include furnishing information, covering events, or gathering information in a state when the information is used or disseminated from outside the state. Protected activity would also include activities related to the purchase of goods or services in a state if the final decision to purchase is made outside the state. The existing safe harbor for the activities of independent contractors in a state would be expanded to include these new categories of protected activity.

The Business Activity Tax Simplification Act of 2009 (H.R. 1083) was introduced by Rep. Rick Boucher, D-Va., and several co-sponsors, and referred to the Judiciary Committee. It is identical to legislation that was introduced in the previous Congress.

The bill can be found at http://thomas.loc.gov/cgi-bin/query/z?c111:H.R.1083:. H.R. 1083, as introduced in the U.S. House of Representatives on February 13, 2009

California: Update on LLC Fee Refund Claims

Earlier this week, the California Supreme Court denied the taxpayer's request to review the CA Court of Appeal's ruling. The CA Court of Appeal's ruling agreed with the taxpayer that the LLC fee was unconstitutional, but ruled the remedy was to refund the difference between the amount of the fee paid by the petitioner and the amount of the fee that would have been required had the fee been fairly apportioned. The taxpayer wanted the CA Supreme Court to review the case and allow full refunds of the unconstitutional fee. The taxpayer is now petitioning the U.S. Supreme Court.

If your CA LLC refund claims are for entities that had sales within and without CA, similar to the taxpayer in this case (Ventas Finance), then you are still waiting for the final determination of the appropriate remedy, partial or full refunds. If I had to bet, I would bet the final determination will be partial refunds. Of course, with CA's budget problems, who knows when refunds will be paid.

Ventas Finance I LLC v. California Franchise Tax Board, U.S. Supreme Court, Dkt. 08-1022, petition for certiorari filed February 10, 2009

Minnesota: Business Tax Changes?

After hearing from tax policy experts, business groups and others, the Governor of Minnesota's 21st Century Tax Reform Commission issued its final report and recommendations:

* repeal the state corporate income tax;
* exempt 20% of active "pass-through" business income from taxation;
* conform to IRC §179 asset expense deduction provisions for business-related assets;
* replace the capital equipment sales tax refund with an up-front exemption;
* extend the capital equipment exemption to businesses that produce services subject to sales tax;
* overhaul the research and development credit by extending it to pass-through entities, increasing the credit amount, and making the credit refundable;
* enact a Small Business Investment Act that would create a venture capital fund for small businesses and create a credit for insurance companies that contribute to the fund;
* enact an early-stage investment tax credit; and
* encourage low-income entrepreneurship and business creation loans.

The commission's report also discussed improvements in transparency by simplifying the state property tax system and requiring a biennial "benefits-received" report of Minnesota business taxation.

Based on the report, the state says it could pay for the tax reform measures by extending the sales tax base to a broader range of consumer products and consumer services and by increasing the excise tax on cigarettes.

Minnesota's Millennium Report, The Governor's 21st Century Tax Reform Commission, February 13, 2009