AICPA Position on the Multistate Tax Commission's Revised Proposed Statutory Language Regarding "Reporting Options for Non-Resident Members of Pass-Through Entities" July 22, 2002
The American Institute of Certified Public Accountants (AICPA) submits the following comments on the Multistate Tax Commission's (MTC) proposed revised statutory language regarding "Reporting Options for Non-Resident Members of Pass-Through Entities" (the Proposal).
According to our understanding, the MTC intends this Proposal to:
- Reduce the cost of collecting tax on non-resident individuals by relieving the related administrative burden for both taxpayers and state tax authorities through a composite filing process;
- Respond to tax practitioner requests to pursue composite filing uniformity among the states; and
- Eliminate a perceived loss of state revenues—based on anecdotal information that taxpayers are engaging in one-time transactions using flow-through entities that allow non-residents to escape state taxation on the transaction's profits or distributions.
After reviewing comments on the first draft of its Proposal, the MTC concluded that mandatory withholding on cash distributions would address these three concerns and issued the current proposal. It is our understanding that the MTC will consider adopting this proposal at its July 28, 2002, meeting in Madison, Wisconsin.
- The MTC has already reviewed and developed model statutory language related to voluntary, uniform filing requirements in its Model S Corporation Income Tax Act (MoSCITA), to which the AICPA and other interested parties have previously provided input. If the Proposal's objective is administrative ease and uniformity, then it makes sense to begin with the MoSCITA and develop the composite filing process from there.
- Withholding at the entity level will impose taxes on many non-resident members who either do not have nexus with the state or do not have a net tax liability with the state due to the non-resident member's credits, deductions, or losses from other sources.
- The Proposal began as a filing options effort and has become more of an entity level tax proposal with withholding requirements. These are distinct issues that deserve to be considered separately.
- States already have the information needed to pursue non-filers in their taxing jurisdiction, and should make greater use of this information, rather than impose a heavy administrative burden on pass-through entities that would require financial system changes and complex tax payments.
- The MTC's anecdotal information indicating that states are suffering a revenue loss by nonresidents who do not file state returns ignores the impact on the revenue of the nonresidents' home states. One of the more significant impacts being the home state's credit for taxes paid to another state. Accordingly, if the nonresident member pays the tax in a state other than its home state, the home state's tax revenue from that individual decreases. On an overall net basis, the revenue pick up under this scenario is neutral. Further study of the revenue impact is needed.
The AICPA supports voluntary, uniform composite return filings for pass-through entities, which would benefit taxpayers, tax practitioners, and tax administrators. However, we are concerned that the MTC's current Proposal does not appropriately achieve this goal.
Based on our members' extensive experience in the practical and logistical aspects of flow-through entity compliance with multiple state tax jurisdictions, we believe that composite filing options for pass-through entities must have the following characteristics:
The following logistical issues related to composite filing—not addressed by this Proposal—should be considered.
The Proposal shifts a large part of the state's administrative burden to the pass-through entity. If the Proposal is adopted, pass-through entities should be compensated for this new burden in a manner similar to the discounts and allowances currently provided for administering sales and use taxes. Fixed credit amounts could be established to compensate the entity based on the number of nonresident owners included in the composite return. Alternatively, a credit equal to the direct cost charged to the pass-through entity for the preparation of the composite return (e.g., the amount of the return preparer's invoice) could be established to compensate the entity. The AICPA would be pleased to assist the MTC in determining the average costs charged for the preparation of such returns.
- Because nonresidents may have other business interests in the state that could offset any income received from the flow-through entity, tax computations on the composite return would result in overpayments. It is unrealistic to expect entities to track each individual's activities within the state and adjust for offsets from other ventures. Other sources of potential overpayment include using the highest marginal rate, lack of uniformity in the tax base, etc.
- The Proposal contains provisions that cannot be adopted through regulation and would require legislative action.
Section 1(B)—We recommend adding optional language clarifying who is a "member." An alternative would be "nonresident individual member". The Proposal should not apply to non-individual members.
Section 1(C)—As currently drafted, the Proposal allows corporations and other business entities to be included in a composite return. As stated above, we believe the proposal should not apply to non-individual members. If left unchanged, we suggest eliminating the phrase "and a business entity that does not have its commercial domicile in the state."
Section 2(A)—Requiring the composite tax to be determined using the highest individual rate without allowance for exemptions, deductions, and NOLs is inappropriate. However, states could allow this method as an option for pass-through entities preferring to compute the tax using a simplified, but more costly method.
Section 2(B)—We suggest amending this section to read: "A non-resident member of a pass-through entity whose only source of income within a state is from one or more pass-through entities may elect to have one or more of the pass-through entities on composite returns…"
Section 2(C)—We strongly recommend striking this section because it would allow each state to establish rules and procedures to carry out these provisions. This is counterproductive to the goal of uniformity.
Section 2(D)—Allowing nonresidents to later file individual returns and receive credit for taxes paid on their behalf by the pass-through entity creates administrative difficulties for the entity. There should be at least a requirement that individuals opting out of returns for which they had elected composite treatment must notify the pass-through entity of their change in status.
Section 3—This section creates enforcement provisions to ensure that all non-participating individuals are actually filing and paying tax. This diminishes the elective nature of the provisions in Sections 1 and 2; is contrary to the overall voluntary nature of this proposal; and, is administratively complex.
Section 3(A)—We recommend that this section be removed, because it has the effect of making the pass-through entity a taxpayer. This section also imposes an unrealistic administrative burden on the pass-through entity, because the entity cannot know whether individuals have losses from other, unrelated business activities in a particular state and, thus owe no tax to that state. The entity should not be liable for taxes owed by an individual who does not elect to participate in a composite return.
Section 3(General)—At a minimum, exceptions to the consent agreement requirements should be made for: