Massachusetts Releases Pass-Through Entity Compliance Guide

If you operate a pass-through entity in Massachusetts, then you need to know for tax years beginning on or after January 1, 2009, Massachusetts adopted new mechanisms for pass-through entities and their members to comply with Massachusetts tax laws.

The pass-through entity compliance program allows members of pass-through entities to choose how they will meet their Massachusetts tax obligations. The compliance program also requires pass-through entities to report to DOR how their members plan to comply.

The pass-through entity compliance program allows non-exempt members of pass-through entities to meet their tax obligation by:

1. agreeing to file and to subject themselves to personal jurisdiction in Massachusetts;
2. participating in a composite return by the pass-through entity; or
3. having the pass-through entity withhold and pay tax on their behalf.

The compliance program generally exempts the following members:

1. Massachusetts resident individuals
2. most Massachusetts estates and trusts;
3. federally tax-exempt organizations;
4. corporations subject to Massachusetts taxing jurisdiction filing their returns including any distributive share from the pass-through entity;
5. pass-through entities that are filing a return; and
6. insurance companies.

To be treated as exempt by the pass-through entity, these members must file an exemption certificate (Form PTE-EX) with the pass-through entity.

For more details, please see Massachusett's GUIDE.

Happy Thanksgiving!

May you enjoy your time with family and friends. May you be truly thankful for the blessings you have, despite what you don't have. May you realize what is most important in life, and achieve true success!

Also, may your state and local tax burdens be light, and your refunds be heavy!

God bless!

Brian Strahle, Your State and Local Taxpayer Advocate

Texas Franchise Tax: Legal Entity Conversion and Tax Planning?

In Texas' November Tax Policy News, Texas discusses the impact when an entity converts from one type of entity to another.

As you may know, the Texas franchise tax was revised in 2006 (House Bill 3, 79th Legislature, Third Called Session) to include partnerships, associations and other entities not previously included in the tax base.

Texas states they will continue to follow the policy established under the prior Texas franchise tax which considers an entity that is legally converting into another type of entity to be a continuation of the original entity. A legal conversion from one taxable entity to another taxable entity will have no effect on the entity's franchise tax filing requirement.

Apparently, Texas has received several inquiries regarding the impact of converting one entity to another. Tax planning, maybe?

In any case, if you think you or your client should consider restructuring or converting your entities in Texas, please contact me to discuss. There are still opportunities to legally minimize your tax in Texas based on limited partnerships qualifying as "passive entities," combined group rules and apportionment.

Also, now may be a good time to have a state and local tax professional review your Texas returns that you filed under the new franchise tax or "Margin Tax."

1. Are you taking all of the deductions you can take?
2. Is your combined group really "unitary"?
3. Did you mistakenly include "passive entities" in your combined return?

For more information, see Tax Requirements for Filings with the Secretary of State.

Illinois: Administrative Hearing Ruling Forces Combination of UNITARY Group

The Illinois Department of Revenue Office of Administrative Hearings has ruled that two groups of businesses under common ownership were related (enough) through strong centralized management by a common parent and functional integration, that they should be forced to file one combined return. The taxpayers in the ruling claimed they were separate unitary businesses. See Ill. Dept. of Rev., Administrative Hearing IT 09-9, 8/24/09 for more details.

I like this case because it provides a good example of how the facts are analyzed in a case involving a unitary determination.

According to the taxpayer, the taxpayer operated two separate and unrelated businesses despite being owned by one common parent and having centralized management. The IL DOR claimed, and the Administrative Law Judge agreed, the evidence of centralized management was strong enough to make the two groups unitary and force combination.

IN GENERAL

As you may or may not know, unitary cases are extremely fact sensitive and open to judgement. Therefore, every case is unique and could go either way. Every state usually lacks uniformity in its laws, but there are several factors that most, if not all, states consider when addressing unitary issues. They are similar to Illinois' definition below:

The term “unitary business group” means a group of persons related through common ownership whose business activities are integrated with, dependent upon and contribute to each other … Unitary business activity can ordinarily be illustrated where the activities of the members are: (1) in the same general line (such as manufacturing, wholesaling, retailing of tangible personal property, insurance, transportation or finance); or (2) are steps in a vertically structured enterprise or process …; and, in either instance, the members are functionally integrated through the exercise of strong centralized management (where, for example, authority over such matters as purchasing, financing, tax compliance, product line, personnel, marketing and capital investment is not left to each member).

APPLICATION

Most states consider or presume groups of companies with common ownership to be unitary. It is up to taxpayers to rebut that presumption.

If you are operating a group of companies which have common ownership, but lack other "forms of connectivity," there may be an opportunity to consider those companies as separate taxpayers, and not unitary.

This not only applies to C corporations, but also to tiered groups of pass-through entities (S corporations, limited liability companies, partnerships) and their owners.

Florida: Apportionment of Software Customization Services Clarified, Conflicting Rules?

If you or your client is providing software customization services and other computer related sales within Florida or to Florida customers, you should be aware that the Florida Department of Revenue recently released Technical Assistance Advisement 09C1-003. The Advisement addresses how income from a taxpayer’s software customizing and other activities should be sourced for purposes of Florida’s sales apportionment factor.

Software Customizing Activities

According to the Advisement, income derived from customizing software should be sourced to the state in which the software customizing activities take place.

Rule 12C-1.0155(2)(h)3., F.A.C., specifically provides that income from customizing software programs should be included in the numerator of the sales factor when the customizing activities take place in Florida.

Other Computer Related Sales

Income derived from other services provided by the taxpayer should be sourced to the location of the customer to whom the service is provided.

Rule 12C-1.0155(2)(h), F.A.C., generally provides for sourcing computer related sales to the location of the customer.

SUMMARY

What we have here are what appears to be two conflicting methods of apportioning income received by a service provider when it involves computer related sales and customization activities.

Customization services = source to state of performance.

Other computer related sales = sourced to state of customer.

However, most likely a company would perform customization activities in the state or location of the customer. Therefore, all of the customization and computer related sales for a specific customer would be sourced to the same state (from Florida's perspective). With that said, there are always exceptions.

APPLICATION?

Whether you operate in Florida or any other state, and you are a computer software company/consulting company, it is a good idea to review the services you provide, what states you perform those services in, and where your customers are located.

How you apportion your income can make a big difference in the amount of state income tax you pay depending on where you and your customers are located. As always, each state may have different rules creating interesting results.

California: BOE Specialists Making House-Calls!

The California State Board of Equalization (BOE) is sending letters to 16,000 retailers in 16 different zip codes notifying them of upcoming visits by BOE specialists.

The affected zip codes receiving letters this month are: Burbank (91505 and 91506); Claremont (91711); Escondido (92025); San Marcos (92069); Moreno Valley (92553); Garden Grove (92841 and 92843); Capitola (95010); Santa Cruz (95060); San Jose (95132 and 95133); West Sacramento (95605 and 95691); Davis (95618); and Sacramento (95811).

The BOE specialists will be canvassing the areas to ensure that businesses are properly registered and paying taxes. The new enhanced compliance effort began in September 2008, with 152 zip codes already notified. Specialists have visited more than 84,300 businesses statewide.

For more info, please see California's Website.

New York: Corporate Tax Reform Coming?

Whether you were aware of it or not, New York Tax Reform appears to be coming soon. The New York Department of Taxation recently released an OUTLINE of the tax reform proposals being considered. The following is a list of some of the highlights included in the outline:

1. The Economic nexus standard would (officially) be adopted (meaning, if you think about 'breathing' into New York, you probably have a taxable presence in New York).
2. Certain exemptions from the tax base would be eliminated along with some changes to what is considered "investment income."
3. The definition of "business income" would become broader (meaning, more of your income would be considered apportionable to New York).
4. All corporations would be subject to one tax rate (yet to be determined).
5. NOLs would not be allowed to be carried back.
6. Business income would be apportioned based on a single sales factor using customer sourcing.
7. Receipts from digital goods would be considered NY sales if the customer is in New York.
8. Receipts from services would be considered NY sales if the customer is in New York.
9. Combined reporting for unitary groups, with more than 50% ownership.

There are additional changes (not mentioned above) included in the OUTLINE. Check it out for all of the fun-filled details.

Texas Franchise Tax (Margin Tax): Last Minute Reminder!

If you or your client is filing a Texas Franchise Tax (Margin Tax) return for the 2008 tax year (2009 Report Year), and you extended the return, then you know it is due November 16, 2009.

Please contact me at brian.strahle@bakertilly.com or 612.876.4824 if you have any last minute questions or would like a second opinion regarding your calculation of:

1. revenue
2. cost of goods sold
3. how to utilize the net distributive income deduction
4. how to determine if your limited partnership qualifies as a "passive entity"
5. how to file a combined return; do you include 100% of the gross receipts of each entity? what entities are included? how do I know if they are unitary?
6. what sales, or what entities' sales in a combined return are included in the numerator of the sales factor?
7. what affiliate schedule do I attach to the return?
8. if I can't pay the tax liability, who is liable? who can the state go after?

Also, for additional information you can visit Texas' Website which contains several frequently asked questions.

Wisconsin: Pass-Through Entity Quarterly Estimated Withholding Tax Payments

According to the Wisconsin Department of Revenue, September 15, 2009, marked the first time many calendar year pass-through entities were required to make quarterly estimated withholding tax payments.

To assist with the implementation of this change, Wisconsin has posted "transitional" guidelines.

Date Dates of Installments

Except as provided during the transition period, a pass-through entity shall make quarterly payments of withholding tax on or before the 15th day of the 3rd, 6th, 9th, and 12th month of the taxable year.

GRACE PERIOD (THIS YEAR)

Section 71.775(4)(L), Wis. Stats., provides a transition or grace period for making estimated payments of withholding tax that become due less than 45 days after July 1, 2009. The due date of these payments is extended to the next subsequent installment due date. For example,

1. A pass-through entity on a calendar year basis would have made its first payment subject to these new provisions on September 15, 2009. This payment would have accounted for the 1st, 2nd, and 3rd installment payments.


2. A pass-through entity on a fiscal year beginning on February 1, 2009, will make its first payment subject to these new provisions on October 15, 2009. This payment must account for the 1st, 2nd, and 3rd installment payments.


3. A pass-through entity on a fiscal year beginning on March 1, 2009, would have made its first payment subject to these new provisions on August 15, 2009. This payment would have accounted for the 1st and 2nd installment payments.


4. A pass-through entity on a fiscal year beginning on June 1, 2009, would have made its first payment subject to these new provisions on August 15, 2009. This payment would have only accounted for the 1st installment payment.

Required Installments

The required amount of each installment (except if computing annualized income under sec. 71.775(4)(h)), Wis. Stats., is 25% of the lesser of the following amounts: (1) 90% of the withholding tax that is due for the taxable year; or (2) the withholding tax due for the preceding taxable year.

The second option does not apply if the preceding taxable year was less than 12 months or if the pass-through entity did not file a return for the preceding taxable year.

In case of any underpayment of quarterly estimated withholding tax, a pass-through entity shall add interest to the aggregate withholding tax for the taxable year at the rate of 12% per year on the amount of the underpayment for the period of the underpayment.

“Period of the underpayment” means the time period beginning with the due date of the installment and ending on either the unextended due date of the return or the date of payment, whichever is earlier. If 90% of the tax due for the taxable year is not paid by the unextended due date of Form PW-1, the difference between that amount and the estimated taxes paid, along with any interest due, shall accrue delinquent interest in the same manner as income and franchise taxes.

However, no interest is required if any of the following conditions apply: (1) the amount of withholding tax due is less than $500; or (2) the amount of withholding tax due is less than $5,000, the pass-through entity had no withholding tax liability for the preceding taxable year, and the preceding taxable year was 12 months.

NEED ADDITIONAL INFORMATION?

For additional information, including information on how to handle withholding exemptions when computing installments, claiming the Form PW-2 affidavit exemption, and how to make electronic payments, see the Wisconsin DOR Website.

If you have questions or need assistance in resolving this compliance matter, please contact me at brian.strahle@bakertilly.com or 612.876.4824.

Minnesota: Tax Refunds Delayed!?

According to the Minnesota Department of Revenue and the Minnesota Management and Budget Office, the state is currently delaying about $128 million in corporate tax refunds to about 460 companies, as well as about $12 million to more than 350 companies. The delay is due to the state’s cash flow problems caused by revenue collections that are $200 million below forecast since July 1.

The refunds are expected to be paid by late December if not sooner. Businesses that receive refunds after 90 days will be paid interest; however, the state is not expecting to have to pay any.

State Residency Audits: Presumptions, Intentions, Acts and Declarations

Do you or your clients split your time between two or more states? If so, you may be subject to a state "residency"audit. Currently, Minnesota is aggressively pursuing "part-year residents" or "nonresidents" via residency audits.

Similar to other states, in Minnesota, residency is generally defined by two rules:

1. domicile or permanent residency; or
2. the 183-day rule.

Exceptions

There are exceptions for members of the military and U.S. citizens that establish a tax home in a foreign country.

Area of Controversy

The term “resident” means any individual domiciled outside Minnesota who maintains a place of abode in Minnesota and spends in the aggregate more than one-half of the tax year in Minnesota, unless the individual or the spouse of the individual is in the armed forces of the United States, or the individual is covered under reciprocity provisions.

“Domicile” or “permanent residence” means the bodily presence of an individual person in a place with the intention of making the place his or her home.

A person who leaves home to go to another jurisdiction for temporary purposes only is not considered to have lost that person's domicile. But if a person moves to another jurisdiction with the intention of remaining there permanently or for an indefinite time as a home, that person has lost his or her domicile in Minnesota. The presumption is that a person who leaves Minnesota to accept a job assignment in a foreign nation has not lost his or her domicile in Minnesota.

Except for a person covered by the provisions of the Soldiers' and Sailors' Civil Relief Act of 1940 (50 U.S.C. App. §574), the presumption is that the place where a person's family is domiciled is that person's domicile.

The domicile of a spouse is the same as the other spouse unless there is affirmative evidence to the contrary or unless the husband and wife are legally separated or the marriage has been dissolved. When a person has made a home at any place with the intention of remaining there and the person's family neither lives there nor intends to do so, then that person has established a domicile separate from that person's family.

The domicile of a single person is that person's usual home. In the case of a minor child who is not emancipated, the domicile of the child's parents is the domicile of the child. The domicile of the parent who has legal custody of the child is the domicile of the child. A person who is a permanent resident alien in the U.S. may have a Minnesota domicile.

The mere intention to acquire a new domicile, without the fact of physical removal, does not change the status of the taxpayer, nor does the fact of physical removal, without the intention to remain, change the person's status.

The presumption is that one's domicile is the place where one lives. An individual can have only one domicile at any particular time. A domicile once shown to exist is presumed to continue until the contrary is shown. An absence of intention to abandon a domicile is equivalent to an intention to retain the existing one. No positive rule can be adopted with respect to the evidence necessary to prove an intention to change a domicile but such intention may be proved by acts and declarations, and of the two forms of evidence, acts must be given more weight than declarations.

A person who is temporarily employed within Minnesota does not acquire a domicile in Minnesota if during that period the person is domiciled outside of the state.

THE 183-DAY RULE

If a taxpayer is a resident of another state, the taxpayer may still be taxed as a Minnesota resident under the 183-day rule.

The 183-day rule depends on two conditions:

1. the taxpayer spends at least 183 days in Minnesota (any portion of a day is counted as a full day); and


2. the taxpayer or the taxpayer's spouse own, rent, or occupy an abode in Minnesota (see herein).

If both conditions apply, the taxpayer is a Minnesota resident for the length of time the second condition applies, If the second condition applied for the entire year, the taxpayer is considered a full-year Minnesota resident for income tax purposes. If it applied for less than a full year, the taxpayer is considered a part-year resident.

If a taxpayer maintains a home in Minnesota, but claims residency elsewhere, the taxpayer must keep adequate records to verify that more than half of the year is spent out of state. Records confirming the taxpayer's whereabouts commonly include planners, calendars, plane tickets, canceled checks, credit card and other receipts. This rule does not apply to military personnel or to people covered by reciprocity.

NEED HELP? Contact Me

As you can see, determining where you live and what state has the right to tax your income can be deceptively simply, and endlessly complicated. If you are undergoing a residency audit or have been contacted by Minnesota or another state, please contact me at brian.strahle@bakertilly.com or 612.876.4824.

See the MN DOR Website for a list of criteria used to determine residency.

To read a review of a recent MN Supreme Court case, see my earlier post, "Minnesota: Do You Know Where You Live?"

Practice Development: Are You Experiencing Client Change?

Clients like paying for time, not hearing from their consultant, being surprised when the bill comes, paying for impractical solutions, being treated like a number, and feeling like their consultant doesn't have a clue about their industry or business. Okay, I am being sarcastic. However, it would seem that consultants don’t always treat their clients in the best manner. I guess that’s why they say, “the greatest gap in life is the one between knowing and doing.”

In addition to the treatment of clients by consultants, the accounting industry lives in an ever-changing world impacted by technological advances and currently, the economic recession. All of these factors can create what I like to call “client change.”

“Client Change” not only describes how clients change their buying habits and demands, but also describes what happens when accounting firms refuse or fail to adapt to client needs. For example, technological advances such as social media and the economic recession have leveled the playing field for firms competing for clients, while also allowing clients to be more selective with whom they choose. Clients are changing what they want, and how they want to receive and pay for services. Clients are also seeking more value from their consultants.

Based on these factors, will accounting firms change? If so, will they change in productive ways? Will they change enough? Or will firms face the ultimate “client change” and lose clients to other firms?

Illinois Partnerships: Partner Compensation Deduction Changes to be Repealed?

Illinois is considering the repeal of changes made earlier this year to the computation of the replacement tax for partnerships. Illinois HB 2239 would repeal SB 1912.

SB 1912

As discussed in an earlier post, SB 1912 will most likely result in partnerships paying more tax. For tax years ending on or after December 31, 2009, partnerships will only be allowed to deduct guaranteed payments for services rendered by partners, and will not be allowed to deduct "reasonable compensation."

If you operate a partnership that pays compensation on performance or some other measure that is not 'predictable' at the beginning of the year, this change may affect you the most.

HB 2239

If signed by the Governor, for tax years ending on or after December 31, 2009, partnerships would be permitted to subtract the greater of (1) income of the partnership that constitutes personal service income as defined in IRC Sec. 1348(b)(1) or (2) a reasonable allowance for compensation paid or accrued for services rendered by the partners to the partnership.

This would remove the negative impact of SB 1912.

The Governor is expected to sign it.

Stay tuned.

Ohio: S Corporation STATUS Filing Requirement WAIVED!

According to an Ohio Department of Taxation Information Release (CFT 2009-02), the Tax Commissioner has waived, for tax year 2010, the requirement that S corporations file form FT 1120S – Notice of S Corporation Status.

The Ohio Tax Commissioner has issued an administrative journal entry, dated Oct. 29, 2009, waiving the filing requirement for S corporations for tax year 2010, based on taxable year ending in 2009.

Accordingly, S corporations do not need to file Form FT 1120S for tax year 2010. Investor information previously reported on the FT 1120S will now be reported on either the (a) IT 4708 – Composite Income Tax Return for Certain Investors in a Pass-Through Entity or (b) IT 1140 – Pass-Through Entity and Trust Withholding Tax Return.

Please see the INFORMATION RELEASE for complete details.

Business Income or Nonbusiness Income? That is the Question.

The Tennessee Court of Appeals affirmed a lower court ruling that the assessment of excise taxes on interest earned from the investment in Treasury securities owned by the taxpayer was unconstitutional because the the income constituted nonbusiness earnings for Tennessee excise tax purposes. In other words, the taxpayer was able to prove that the income from the Treasury securities was for investment purposes only and was not connected to the company's business in Tennessee.

This case provides yet another example of the controversy and difficult analysis that results from a business income versus nonbusiness income tax position. In this case, Tennessee acted like most states do in that they took the position that the income was business income and should be apportionable to their state. It is usually up to the taxpayer to prove by the preponderance of their facts that the income is nonbusiness and should be allocated to the taxpayer's home state or a different state depending on the type of income and circumstances.

Please see the case for more details, Siegel-Robert, Inc. v. Johnson, Tenn Ct. App. at Nashville, Dkt. No. M2008-02228-COA-R#-CV, 10/28/2009. After you click on the link, type "Siegel-Robert" in the search field. The case will be document #2.

Application to Your Company and Other States

If your company has some type of income that you believe is not part of your "ordinary trade or business," it could be very beneficial to have a review or analysis completed to establish the legal and business case for treating that income as nonbusiness income. The earlier the business case can be established, the better.

Even if your company has treated the income as business income for years, if your facts or operations change, an argument or position may be able to be taken to treat the income as nonbusiness. Depending on the amount of income and states involved, the resulting impact can be very material.

Impact of FIN 48

In addition to the state tax ramifications, FIN 48 most likely will create the need for companies to document their support for treating certain income as business or nonbusiness income for financial statement purposes. Therefore, a review can "kill two birds with one stone."