An Update on the State Tax Treatment of LLCs and LLPs
The owners of multistate businesses must consider many factors when deciding how to structure their business ventures, and state taxation should not be overlooked. The accompanying tables can assist in that evaluation for limited liability companies and limited liability partnerships.
In recent years, LLCs and, to a lesser extent, limited partnerships and LLPs have become the popular choice for structuring or restructuring multistate business entities. According to recent IRS statistics, more than two-thirds of all subchapter K entities are now domestic (U.S.) LLCs, surpassing all other entity types for 16 consecutive years.
The accompanying tables summarize the differences in the tax treatment of LLCs and LLPs across the 50 states and the District of Columbia. The tables discuss state tax considerations, such as conformity with the federal income tax classification rules, entity-level taxes, and potential entity-level withholding or composite return requirements. We hope that the footnotes will also be useful, especially those listing the states that exempt qualified investment partnerships (QIPs) or their nonresident partners from state income tax and nonresident partner withholding.
Series LLCs — A Hot Idea That Seems to Have Cooled?
Like LLCs, the use of series LLCs to structure a multistate business has grown in popularity in the past 10 years or so. The last column of Table 1 shows which states have enacted series LLCs statutes and which state taxing authorities have issued guidance on how these odd creatures are to be taxed. It reflects helpful input from the American Institute of CPAs State & Local Tax Technical Resource Panel and from many state revenue authorities, for which we are thankful.
In September 2010 the U.S. Treasury Department issued helpful proposed regulations explaining how a series LLC would be treated for federal income tax purposes.1 We hope that Treasury will issue final series LLC regulations this year, although this project has been downgraded several times, most recently by the need for numerous regulations and other guidance after the Tax Cuts and Jobs Act of 2017 and more recent tax stimulus legislation. Once the regs are finalized, we anticipate that several states will enact legislation authorizing the formation or qualification of series LLCs, and that many will publish some form of guidance on how each series and the “mother ship” LLC itself are to be taxed for a variety of state taxes, including unemployment compensation taxes or premiums. Our table lists the handful of states that have grown impatient and enacted series LLC legislation despite the lack of official guidance. We anticipate the introduction of series LLC bills in several state legislatures this spring.
PTE Taxes as SALT Cap Workarounds — Now Will They Work?
The latest version of Table 1 includes the seven states that, since the last update, have enacted passthrough entity level income taxes in response to the TCJA’s $10,000 limitation on state and local tax deductions by individual taxpayers.2 Connecticut was the first state to enact legislation expressly designed to use PTEs as an indirect means to circumvent the so-called SALT cap.3 Retroactive to tax years beginning on or after January 1, 2018, LLCs and LLPs are subject to a 6.99 percent PTE tax on their net income. Connecticut’s tax mandates that PTEs pay the income tax at the entity level.4 The owners of the PTE receive a not quite corresponding credit (now reduced to 87.5 percent) against their Connecticut income tax liability.
Wisconsin was the second state to enact an avowed SALT cap workaround in a PTE tax.5 For tax years beginning on or after January 1, 2019, some PTEs may elect to be taxed at the entity level, at the corporate tax rate of 7.9 percent. As the accompanying tables indicate, six other states have followed suit, each with an elective (versus a Connecticut-style mandatory) PTE tax regime: Wisconsin, Oklahoma, Louisiana, Rhode Island, New Jersey, and most recently, Maryland. Unfortunately, no two PTE tax snowflakes are alike.
A similar elective workaround bill (S.B. 1170) passed Michigan’s House of Representatives and Senate but was vetoed by then-Gov. Rick Snyder on December 28, 2018, with a warning of a likely IRS challenge if the bill were enacted. Former California Gov. Jerry Brown also vetoed a bill in 2018 designed to circumvent the federal SALT deduction cap by a different means. In March 2019 Michigan Gov. Gretchen Whitmer (D) introduced her own version of a PTE tax, H.B. 4781, but this version was mandatory, and (we understand) partly because of the lack of the option, the bill eventually died.
Other state legislatures that considered PTE tax legislation in 2020 and will likely reconsider it this year include Alabama, Arkansas, Minnesota, and New York. Earlier this year, California Gov. Gavin Newsom (D) announced tax incentive and relief proposals that, among other things, included a SALT cap workaround for S corporations (but not LLCs or partnerships). That bill is now S.B. 104. The New York legislation is now S. 2509/A. 3009. The Massachusetts legislation is included in the governorʹs budget proposal as section 28. We expect several other state legislatures to consider PTE tax legislation this year, even though prospects of an early repeal, or more likely an increased SALT cap, are greater considering the different composition of the Congress as of January 20, 2021.
The driving force behind these recent state legislative efforts is largely the issuance of IRS Notice 2020-756 in early November 2020, in which the IRS announced its intention to issue regulations providing guidance supporting partnerships and S corporations deducting amounts qualifying as “specified income tax payments,” that is, PTE tax liabilities imposed by a state, political subdivision of a state, or the District of Columbia. The deduction will be available to partnerships and S corporations in computing their non-separately stated income or loss, regardless of whether the liability is the result of an election by the entity, or whether the partners or shareholders receive a partial or full deduction, exclusion, credit, or other tax benefit based on their share of the amount of tax paid by the entity.
Table 2 lists the states that impose a net worth-based or debt-based corporate franchise tax, and which of those states either statutorily subject LLCs, LPs, or LLPs to that tax or exempt them, also as of January 1, 2021.
While we hope these tables are a useful research tool, they are clearly only a starting point. They should not be relied on as a definitive source of information. And we always welcome statutory or administrative updates.
Republished with permission. The full article for, "An Update on the State Tax Treatment of LLCs and LLPs," was published in Tax Notes State, Vol. 99, No. 6 on February 8, 2021, and can be accessed here.