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Taxation of Flow Through Entities in a Multistate Context


By Charles R. Beaudrot, Esquire
Morris, Manning & Martin, LLP
crb@mmmlaw.com
404.504.7753

Introduction

The taxation of Partnerships, S Corporations and other "flow through" entities on a multistate basis has long been a complex and unsettled area. See, e.g., American Bar Association Subcommittee on State Taxation of S Corporations; Report of the Subcommittee on State Taxation of S Corporations: Model S Corporation Income Tax Act and Commentary, 42 The Tax Lawyer, 1001 (1989); Multistate Tax Commission, The Multistate Tax Commission "Working Draft" of a Proposed Model Rule for a Partnership Composite Tax Return Applicable to Multijurisdictional Partnerships, 3 State Tax Notes 810 (1992). This area continues to assume even greater importance with the proliferation of additional forms of flow through entities, including limited liability companies ("LLCs"), limited liability partnerships ("LLPs"), limited liability limited partnerships ("LLLPs"), qualified subchapter S subsidiaries ("QSSSs") and disregarded single member limited liability companies ("Nothings" or "SMLLCs".)

The purpose of this outline will be review major issues that affect the taxation of flow through entities at the state level in a multistate context using Georgia as a particular illustration of some of the difficulties posed.

Attached materials

Attached at the end of this outline are two useful charts which are helpful in analyzing on a multistate basis the taxation of flow through entities.

1. S Corporations.

The first chart, attached as Exhibit 1 is a summary of the state-by-state treatment of subchapter S Corporations which was prepared by Pricewaterhouse Coopers LLP and is used by permission. Although not completely current, this is an extremely helpful stating point for determination on a state by state basis of how to address S Corporation tax issues.

2. LLCs, LLPs and SMLLCs.

The second chart attached as Exhibit 2 is an excellent summary prepared by Bruce Ely of Tanner & Guin, L.L.C. in Tuscaloosa, Alabama which summarizes the current status of the tax treatment of limited liability companies, limited liability partnerships and single member LLCs.

Flow Through Status Issues

1. Is the S Corp Flow Through Status Recognized for State Tax Purposes?

Treatment of S Corporations varies from state to state. These fall generally into four categories:
  1. Unconditional Recognition. States which unconditionally recognize federal S status, which adopt the flow through nature of S corporations and generally impose no state income tax on S corporations. (In Georgia, this occurs if all the owners are residents of Georgia. O.C.G.A. §§ 48-7-21(b)(7)(B), 48-7-27(d)(i); Regs. §560-7-3-.06(6)).
  2. Conditional Recognition. (Special Shareholder ConConsents/Elections). States which condition the recognition on special shareholder consents or elections. (In Georgia, this rule applies where some shareholders are non-residents. O.C.G.A. §§ 48-7-27(d)(2)).
  3. Non-Recognition. States that specifically refuse to recognize S corporation status and tax all S Corporations as C Corporations in their state (e.g., Tennessee).
  4. Modified Federal Recognition. States that recognize federal S status with some limitations or modifications to federal tax treatment.

See generally, Exhibit 2; see also Tax Planning for S Corporations, "State Tax Treatment," Chapter 13A, Matthew Bender & Company.

2. Mechanics of State by State S Corp Elections.

Among the states that recognize federal S status, no uniform procedure exists for approving that status. The majority of the states accept the federal S election as automatic approval of the S Corporation status for state income tax purposes. A significant number, however, require that shareholders file a separate state election or consent as a condition to approval of the federal status. For example, Georgia O.C.G.A. § 48-7-27(d)(2) requires that all non-resident shareholders consent to the effectiveness of the election of S status and conditions the validity of the consent on the non-Georgia shareholders consenting to jurisdiction for taxation in this state.

Because some states require that non-resident shareholders consent to the S Election, it should be noted that changes in residence of an S corporation shareholder may require additional filings. For example, if an Atlanta resident who is the sole shareholder of an S Corporation retires to Florida, but the S Corporation continues its domicile in Atlanta, the S Corporation must now make the Georgia election for the S Corporation status to continue to be recognized for Georgia purposes.

3. Is a Qualified Subchapter S Subsidiary Recognized for State Tax Purposes?

The introduction of the QSSS has created an additional set of problems in the S corporation area. Under IRC § 1361(b)(3), for federal income tax purposes, a corporation which is a Qualified Subchapter S Subsidiary is not treated as a separate corporation and all of its assets, liabilities and items of income deduction and credit are treated as assets, liabilities and such items of the parent S corporation. A corporation may elect QSSS status if it is a 100% owned by an S corporation and that S corporation elects to treat the subsidiary as a QSSS.

  1. Consequences of the Federal QSSS Election.

    Although a QSSS is disregarded for federal income tax purposes, it is a valid corporation formed under state law and possesses all of the well established characteristics of any duly formed corporation. This is notwithstanding that the tax attributes are attributed to its parent for federal tax purposes.


  2. Current State Treatments of QSSS.

    The treatment of QSSSs follows three current patterns:
    • Conformity to the federal treatment;
    • Intentional nonconformity; and
    • Uncertainty.


  3. Conformity to Federal Treatment.

    In many states, because the state tax system incorporates a federal conformity system, the QSSS election will automatically flow-through to the state return.

    Moreover, because in many states the applicable corporate income tax definition is derived from the federal definition (as is the case in Georgia, O.C.G.A. § 48-7-21), in many cases the income conformity language may resolve the issue if the corporation is taxable on an income base derived from federal taxable income because a QSSS has no federal taxable income tax base to be adjusted so it has no separate state level taxable income. Thus, even assuming the QSSS election is not specifically respected in such states there would be no separate taxable income base to which the state tax would attach. See, e.g., O.C.G.A. § 48-7-21; Reg. § 560-7-3-.06; O.C.G.A. § 48-7-21(7)(B).


  4. Intentional Non-Conformity to Federal Treatment.

    Where a state does not accept a federal QSSS election and taxes the QSSS as a corporation, it should become apparent that if the QSSS conducts business in more than one jurisdiction, the entity runs the risk of taxation at the entity level in some states which may or may not be creditable or deductible against a separate liability of its parent S Corporation or the parent’s shareholders.

    States address this to varying degrees. In Georgia, for instance, in such case the S Corporation and its shareholders presumably could avail themselves of the right to make an appropriate "adjustment" to recapture any resulting tax detriment under O.C.G.A. § 48-7-27.

    Fortunately, in those states which recognize S Corporations generally, the move to accept the QSSS election appears to be gaining ground. For instance, after well publicized non-conformity, California has accepted the QSSS election, although potential traps remain. See Kathleen K. Wright, Going With the Flow-Through: Update on California’s Sub S Conformity, State Tax Notes, June 22, 1998, pp. 1989 - 1992.


  5. Uncertainty.

    Not surprisingly, many states have not yet addressed the issues specifically, raising interesting questions of proper treatment. See generally, Carolyn Joy Lee, Checking Oneself Into A Box: State Tax Issues for Federal See Through Entities, 12 State Tax Notes 1249, April 21, 1997. Again, sometimes a state’s definitional structure of taxable income, if it adopts the federal income tax base as the starting point, may address the issue indirectly.

4. Other State Taxes Applicable to S Corporations.

Even assuming that an S Corporation is recognized as a non-taxable flow-through entity by a state, this generally does not relieve the S Corporation of other state, corporate or entity taxes, nor from costs or requirements of qualification or regulation to do business. Thus, for instance, in Georgia, S Corporations must still file a Georgia net worth tax return. O.C.G.A. § 48-13-72. Similarly, in other states such as Texas, the corporate franchise tax is due, Tex. Tax Code Law § 171.002, and many states such as California continue to nick S Corporations, including QSSSs, with minimum franchise taxes. (Ca. Dev. & Tax Code § 23800.5(b)(1)(A) and (B); see generally, Wright, supra), as part of an effort to "recapture" what, from the state’s perspective, is "lost" revenue.

5. Are Partnerships, LLPs, LLCs and SMLLCs Treated as Flow Through Entities for State Tax Purposes?

With the proliferation of new forms of hybrid entities such as LLCs, LLPs and LLLPs, which partake of aspects of both corporations and partnerships state law classification issues are growing in complexity and number. Under the final Treasury Regulations (Reg. § 301.7701-2, the "Check-the-Box" regulations) such entities, by default, are taxable as partnerships at the federal level. Because of the increasing use of such "flow through" entities for a variety of business issues at the state level continue to assume even greater prominence.

  1. Partnerships.


    2. Virtually all states recognize traditional general partnerships and limited partnerships as flow through entities for taxation purposes. See, e.g., O.C.G.A. § 48-7-23. The main issues here are not so much status issues but the applications of taxation to the model of a flow through entity. These major issues of how much income is taxable in each state (apportionment and allocation of income as applied to partnerships), the availability of composite returns and withholding on non-residents are discussed below in Sections V.

  2. LLCs and LLPs.

    Because of their hybrid nature and similarity to corporations by reason of enjoying limited liability, the status of LLCs and LLPs has been less clear. The attached Ely chart summarizes admirably the current treatment of these various entities for federal and state purposes. In Georgia, the LLC Act requires federal conformity. O.C.G.A. § 14-11-1104.


  3. Single Member LLCs.

    Under Check-the-Box, the ability to create an SMLLC or Nothing which is disregarded for all federal tax purposes under the Check-the-Box regulations (Treas. Reg. § 301.7701-2(a), 301.7701-3(b)) creates another opportunity for federal/state nonconformity. The current status of pronouncements on treatment of Nothings is also summarized on Exhibit 2. Several states continue to be nonconforming to federal treatment with the resulting consequence of considerable uncertainty on the interface between the conflicting state rules on the taxation of SMLLCs. A particular concern is the issue that assuming separate taxation is imposed at the flow through entity level, how does the owner entity obtain a correlative tax benefit (i.e., whether it is a deductible expense or treated as a creditable item against other income of the parent). For a discussion of this issue, see Carolyn Joy Lee, Checking Oneself Into a Box: State Tax Issues for Federal See Through Entities, supra, 1249, April 21, 1997. Again, in Georgia, the LLC Act mandates federal/state conformity for single member LLCs. O.C.G.A. § 14-11-1104.

Issues in the Taxation of S Corporations on a Multistate Basis

1. Flow Through Treatment.

Assuming that S corporation status is recognized such that the election is valid for state law purposes, then the S corporation’s income flows through to its shareholders and is taxed to them individually.

As noted above, many states unconditionally recognize the federal subchapter S election. In the case of Georgia, this is true if all of the owners are residents of Georgia. See O.C.G.A. §§ 48-7-21(b)(7)(B) and 48-7-27(d)(1); Regs. § 560-7-3-.06(6).

If, however, the election is not recognized, the entity level taxes accrue. The issue then becomes how, if at all, the shareholder can obtain a credit or benefit for the entity level tax.

2. S Corporations With Non-Resident Shareholders.

Where the S corporation has non-resident shareholders, many states, such as Georgia, will recognize the election only so long as all of the non-resident shareholders of the corporation execute a consent agreement to pay income tax on that state’s portion of the corporation’s taxable income or some similar election. See O.C.G.A. § 48-7-27(d)(1). In Georgia, the consent agreement must be filed with its Georgia S corporation tax return (Form 600S). The instructions on that form state that the consent should be made on Form 600S-CA.

In Georgia, if an S Corporation is not recognized for Georgia tax purposes, it is required to file a regular Form 600 and pay regular corporate income tax. However, the Georgia shareholders may make an adjustment to federal adjusted gross income in order to avoid double taxation on this type of income. See O.C.G.A. § 48-7-27(d)(2). However, such adjustments are not allowed unless tax was actually paid by the S corporation.

By contrast, a state which does not permit such an adjustment would see the shareholders in such a situation be taxed twice. Interestingly, however, presumably the base for such taxation will be tied to actual distributions as opposed to constructive or deemed distributions. There will be times when this can be manipulated to reduce shareholder taxes.

3. Apportionment and Allocation of S Corporation Income.

One of the difficulties of dealings with S corporation is the proper determination of the taxable income base on which the tax is paid. Many states address this issue only inferentially or in part. Moreover, the methods of apportionment and allocation used to assign income may be different from state to state.

QSSSs also raise some interesting issues for states which use the unitary model for the computation of taxable income base, particularly if the QSSS subs are multistate operations and non-unitary. Specifically, the question can arise as to whether the combined reporting factors are of the S Corporation and the QSSS or to the QSSS on a stand-alone basis.

4. Taxation of Resident S Corporation Shareholders.

Because most states tax their shareholder resident individuals on the resident’s entire federal taxable income subject only to adjustments and because the income of a shareholder of a federal S Corporation includes such shareholder’s entire share of the S Corporation’s income, the resident shareholder will generally be taxable on all of such shareholder’s share of the S Corporation’s income in his state of residence. If some of this income has also subjected the shareholder to tax liability in another state, either through direct entity level liability or withholding, such income will be susceptible to double state income taxation unless a credit is given or adjustments are made for such tax.

A Georgia resident is taxable on all of his income subject only to a reciprocal credit for taxes paid in other states. Therefore, in the event the S Corporation has non-Georgia income, which is subject to tax in other states, the Georgia resident will be entitled to a credit for taxes on such income. See O.C.G.A. § 48-7-28. He will be fully taxable on that income, however, to the extent not taxed in other states.

5. Taxation of Non-Resident S Corporation Shareholders.

Assuming that an S Corporation has non-resident S Corporation shareholders, the issue arises how such shareholders are taxable. Putting aside for the moment constitutional issues on the power of states to tax non-residents on their distributive share of corporate income, many states (such as Georgia) have addressed the issue by either requiring the non-resident to consent to taxing jurisdiction of the state (e.g., O.C.G.A. §§ 48-7-21(7)(21) and 48-7-27(d)(2)), or else imposing a direct liability on the entity (e.g., O.C.G.A. § 48-7-21(7))B), or imposing a withholding obligation with respect to distributions to non-residents shareholders (e.g., O.C.G.A. § 48-7-129).

Non-resident shareholders of an S corporation with Georgia source income are required by the statute to pay tax upon the non-resident’s share of the corporation’s "Georgia taxable income." Reg. § 560-7-3-06(6). With respect to an S corporation that does business both within and outside of Georgia, formerly neither the Code nor the Regulations contained specific guidance on how this was to be computed. Upon the enactment of O.C.G.A. § 48-7-129 in 1993, however, and, perhaps more importantly, the adoption of Regulation § 560-7-8-.03(2)(b), the regulations have now specifically formalized that partnerships and S corporations with income from both within and without the State of Georgia must apportion such income based upon O.C.G.A. § 48-7-31(c) and(d). Thus, in Georgia (and states which follow this model), the non-resident’s taxable Georgia income base will be the apportioned share of income in Georgia computed using Georgia’s three factor/double weighted apportionment formula.

6. Special Entity Level Taxes.

Another issue that often arises in multistate context is whether the state imposes similar entity level taxes that follow federal taxation. These include the excess capital gains tax of prior law IRC § 1374, the built-in gains tax of current IRC § 1374 and the IRC § 1375 excess net passive income penalty. Georgia is one of those states which follows federal law and taxes such income. See, generally, Exhibit 1.

7. Withholding.

To ameliorate the real constitutional limitations and practical difficulties of taxation of non-resident S Corporation shareholders, as can be seen from reviewing Exhibit 1, the states generally use either the imposition of a withholding obligation on the S Corporation or on distributions, require entity level composite returns and entity level payments, or waive the withholding obligations if the composite returns are filed and the amounts shown due thereon were paid. Georgia follows the last alternative. The statutory mandate appears at O.C.G.A. § 48-7-129 and requires withholding at a vote of 4% on distributions to non-residents. This withholding obligation is excused as to non-residents upon filing of composite returns by the S Corporation on and remittance of tax on behalf of the non-resident.

8. Composite Returns.

A composite return in the S Corporation setting is one in which the entity files a return on behalf of its shareholders and pays tax with respect to the shareholder’s respective shares of entity level income. Its use is widespread, but by no means universal, as to S Corporations and the availability of such returns can only be obtained through a specific approach to the applicable state revenue department. This is often an extremely pragmatic solution as it permits the entity, which is often best situated to do so, to comply with state tax rules, thus reducing cost and simplifying compliance.

In Georgia, prior to the enactment of O.C.G.A. § 48-7-129 the statutory basis for the use of composite returns for S Corporations and partnerships in Georgia was unclear, at best. See, Patrick G. Jones, Georgia Taxation: Partners and S Corporation Shareholders, The Atlanta Lawyer, Vol. 40, No. 1 (1993). The enactment of § 48-7-129, however, expressly sanctioned this vehicle. The regulation which appears as Reg. § 560-7-8-.34 contains extremely useful guidance on a number of critical issues, not merely in the area of withholding, but the taxation of flow through entities generally, such as the application of apportionment and allocation principles to flow through entities generally.

It should be noted that composite returns are not available where the non-resident S Corporation shareholder has other Georgia source income. In those cases, the withholding requirement is not excused for such resident shareholders although the S Corporation may file a return for those non-residents who are eligible.

Issues in the Taxation of Partnerships on a Multistate Basis.

The taxation of partners and partnerships in a multistate setting is, if anything, more unsettled than taxation of S corporations.

For purposes of this section, the term "partnership" will be applied to all entities which are taxable as flow through entities for state tax purposes on the same basis as they are recognized as flow through entities for federal purposes. Thus, for instance, the discussion of this section will apply to an LLC or other entity which is taxable as a partnership but not to an LLC or other eligible entity which has elected to be taxed as an association taxable as a corporation.

Although S Corporations pose significant issues in a multistate context, the applicability to taxation of Partnerships is perhaps even more acute. The dilemma arises from the fact that although an S corporation is a form of "flow through" entity, it is generally viewed as a separate entity for tax purposes. Partnerships, on the other hand, are hybrid entities and often partake of aspects of both an entity or an aggregate. In the setting of the classic multistate general partnership, the application of aggregate concepts is closely related to the concept of a partnership as a cross agency in which each partner can bind the other partner. Under this model, it is a small step to view each partner as engaged in a business activity in each state in which the partnership has a partner. In the setting of a limited partnership or a limited liability company, however, this logic may not hold. In such situations, the interest of the limited partner or the member of a manager-managed LLC may be much more analogous to the interest of a corporate shareholder. As a consequence, the simple extrapolation of rules evolved for application to general partnerships may or may not withstand analysis when applied to such "hybrid" partnerships.

1. Taxation of a Domestic Partnership and Partners.

Before passing to the more complex situations, it is perhaps best to begin with the analysis of the simplest form of partnership taxation. Assume a domestic partnership with all domestic partners. In such a model, the taxation in most states is relatively straight forward. A determination is made of the partnership’s net taxable income. In Georgia, for instance, the net income of the partnership is computed in the same manner as for an individual, except that the deduction for charitable contributions is not allowed. O.C.G.A. § 48-7-23 (Reg. § 560-7-3.08(a)). Each partner is then required to include in such partner’s tax return for the year the partner’s distributive share, whether distributed or not, of the net income for the partnership for the taxable year. In this, the model generally follows the federal model applicable to partners and partnerships. In Georgia, for instance, O.C.G.A. § 48-7-23 and Reg. § 560-7-3.08(2) explicitly requires the inclusion of the full amount of the income. Although the statute does not address tax losses explicitly, the Regulations make it clear that a net loss would be subject to the same rules of computation at the entity level followed by allocation to the partners. Reg. § 560-7-3.08(3). Again, because in most states the taxation of individuals is derivative of federal adjusted gross income, this result is harmonious with the federal tax treatment and is relatively simple to apply.

2. Taxation of Domestic Partners of a Multistate Partnership.

Problems begin to emerge when the Partnership is engaged in multistate business. Again, usually because the computation of the state’s taxable income begins with the federal adjusted gross income definition, which of course would pick up all of the partner’s distributive share of partnership income, the partner is required to report his entire income and pay tax on it in a state residence, subject only to a credit for taxes paid in other states or other permitted adjustments. Georgia follows this model: The Georgia resident is required is report on his Georgia tax return his entire distributive share (whether distributed or not) of the Partnership’s entire net income and not just the Partnership’s Georgia net income. See O.C.G.A. § 48-7-24(b); Reg. § 560-7-3.08(6); Head v. Maxwell, 60 Ga. App. 488 (1938). However the resident partner is entitled to a credit against his Georgia income tax liability for any taxes paid to him to other states on the Partnership’s income, although such credit cannot exceed the tax that would have been payable by the Georgia resident on such income had it been taxable in Georgia. O.C.G.A. § 4-7-28.

It should be noted that in this situation the resident may find himself in the difficult situation if his home state does not permit a full credit for any tax imposed by another state in which the Partnership does business. The integration of the resident’s tax in rules with the withholding or composite return requirements imposed on the Partnership with respect to its income from another state on a multistate basis can easily result in situations where there is not full congruence between the taxing jurisdictions.

3. Taxation of Non-Resident Partners In A Partnership Doing Business on a Multistate Basis.

The most difficult situation arises with a Partnership which is doing business on a multistate basis and earning state income in multiple states and the interface between the taxing regimes of the states in which the income is earned and the state in which the partner resides.

  1. Tax Jurisdiction.

    The first question which must be determined is whether the Partnership has the requisite degree of jurisdictional contact with each state to determine whether it is subject to that state’s regime of taxation on its income. This level of activity is often poorly articulated. For instance, O.C.G.A. § 48-7-24(a) addresses the issue only tangentially and indirectly. It provides, that non-residents which are members of a "partnership doing business in this state" are subject to tax on their share of the net profits of the partnership. A non-resident for these purposes is any individual who is not a resident. See O.C.G.A. § 48-7-1(6)(7)(11). Residents are defined in O.C.G.A. § 48-87-1(10).

    Thus to determine if the non-residents partners are taxable in Georgia, it is first necessary to determine that the Partnership is doing business. There is no statutory definition specifically applicable to partnerships. Presumably, however, the same standards which are used in determining whether a corporation is doing business are applied by analogy. See Reg. § 560-7-7.03(1). See also generally, Hawes v. William L. Bonnell Co., 116 Ga. App. 184 (1967) quoting the Georgia Supreme Court in Redwine v. United States Tobacco Co., 209 Ga. 725 (1953).

    It is not entirely clear that O.C.G.A. § 48-7-24(a) applies to corporations. By its term, the section applies only to "individual partners". The Department of Revenue in its audit procedures and, the Georgia Court of Appeals, by implication, have indicated that the same logic would apply to corporate partners. See Bessemer Auto Parts, Inc. v. State Revenue Commissioner, 110 Ga. App. 500 (1964).


  2. Determination of Taxable Income.

    Assuming that it has been determined that a Partnership has the requisite nexus with the state, the question then arises as to the determination of the proper taxable income base on which the tax liability is computed. The answer may be different depending on whether the partner is an individual or a corporate taxpayer.


  3. Individual Partners.

    For instance, in Georgia, if the non-resident partner is an individual, that partner is taxable in Georgia only on the partner’s share of the Partnership’s income that is attributable to Georgia. O.C.G.A. § 4-7-30(b). Under this section, the non-resident partner’s taxable income may be determined by a separate accounting of the income if the Commissioner is satisfied that separate accounting reflects correctly the income fairly attributable to Georgia. Otherwise, the amount of income attributable to Georgia is required to determine utilizing those formulas for allocation apportioning of income of corporations engaged in business within the state. These rules are contained in O.C.G.A. § 48-7-31, but the detailed applicability is left generally to the instructions on the Georgia Partnership Income Tax Return (Form 700). The partner is then required to pay tax on the resulting number.

    It should be noted that Georgia does not for these purposes distinguish between individual general partners and individual limited partners. In this respect, it is consistent with the Georgia Code, which draws no such distinction.


  4. Corporate Partners.

    Taxation of corporate partners in multistate partnerships raises interesting problems because in many circumstances the corporate partner itself is subject to multistate taxation and therefore must be engaged in the process of apportioning and allocating its income on a multistate basis. Thus, the question often arises whether for purposes of computation of the corporate income tax base whether the corporation’s income from the Partnership will be determined on "entity" basis or on an "aggregate" basis.
    1. Entity Model. Under the entity approach, the Partnership is treated as a separate entity distinct from its partners and the corporation is taxed on its distributive share of the Partnership income determined separately.
    2. Aggregate Model. Under the aggregate approach, however, the Partnership "flows through" to the corporate partner the corporate partner’s proportionate share of each item of gain, income, loss, deduction or credit, and perhaps more importantly for state law purposes, the corporation picks up from the Partnership the corporate partner’s respective shares of gross receipts, property and payroll for purposes of the computation of its apportionment and allocation formula in its own tax basis.
    3. Although this result varies from state to state to state, Georgia represents a curious example of a hybrid response to this problem. In Georgia, the Department of Revenue takes the position that ownership by a foreign corporation of a general partner interest in a partnership that is doing business in Georgia will in of itself create nexus with the state of Georgia. However, the Department takes the position that ownership of a limited partnership interest will not. The Department views the ownership of a limited partner interest as analogous to an ownership of stock in a subsidiary, which by itself would not give the parent corporation nexus in the State of Georgia.
    4. Intersection with Corporate Apportionment Formulas. In Georgia O.C.G.A. § 48-7-21(a) provides that the Georgia income tax will be imposed only on the taxable income that is derived from "property owned or from business done in this state." O.C.G.A. § 48-7-31(b)(2) provides that if the business is derived on a multistate basis, it is imposed only on the business income which is reasonably attributable to property owned and business owned within this state. The Regulations now provide that a foreign corporation is required to include in its apportionment factors for its Georgia income tax base its prorata share of partnership property payroll and gross receipts if it is involved in a "business joint venture or is a general partner". See Reg. § 560-7-7.03(5)(f).

      Presumably, the corporate partner in such a situation would include its proportionate share of the various items of payroll, property and gross receipts in order to compute its basis for apportionment of income.

      On the other hand, if a foreign corporation is a limited partner in a limited partnership doing business in Georgia, the Department’s position is that such Partnership’s property, payroll and gross receipts do not flow through to the foreign corporate limited partner. Instead, the partnership’s income is apportioned and allocated at the partnership level and the foreign income’s distributable share of the Partnership’s Georgia income is subject to allocation.

      The logic behind this appears to be that a limited partnership interest is an intangible asset. See Maxco, Inc. v. Volpe, 247 Ga. 212 (1981) corrected by 251 Ga. 892 (1984) ["the property interest held by a limited partner is intangible personal property];" Reliable Tractor, Inc. v. Strickland, 13670 (Tift County Superior Court, February 2, 1978) ["an interest in a limited partnership constitutes intangible personal property"]. Many states provide that income from an investment in an intangible asset is subject to allocation rather than to apportionment. Allocation generally requires that such intangible income be allocated to the domicile of the corporate taxpayer. Thus, the corporate partner will only be taxable on such income in Georgia if it is a domestic corporation, a domesticated foreign corporation, an undomesticated foreign corporation having its principal office in Georgia or if the corporate partner’s interest in the partnership was acquired as a result of business done of property owned in Georgia. O.C.G.A. § 48-7-31(c)(1); Regs. § 56-7-7.03(3)(b). A "domesticated foreign corporation" is defined in O.C.G.A. § 48-6-20(3.1), but this will not apply to most foreign corporations. Thus if a foreign corporation is not a domesticated foreign corporation and does not have its principal office in Georgia, its share of the limited partnership’s taxable income will be taxable in Georgia only if such corporation’s limited partner interest was acquired as a result of business done or property owned in Georgia. If not, it will escape Georgia taxation.

    5. Open Questions. This extended discussion does not at any way address the proper treatment for these purposes of an interest held by a non-resident in a limited liability company. There is a substantial argument that the same rules that apply to limited partnership interests should apply to limited liability company interests, particularly in manager-managed LLCs where the owner is not a manager. It should be noted, however, that at least in the withholding area the Revenue Department has rejected this analysis. Regs. §560-7-8-.34(2)(c) recognizes an exemption from withholding for corporate limited partners. Although not articulated, the logic for this exception appears to be based on the analysis of whether a limited partnership interest is treated as an intangible asset, like stock. Given the similarities between limited liability company interests and limited partnership interests, maintaining that the "entity" approach is the correct approach for a corporation which holds a limited partnership interest but the "aggregate" approach is correct for an LLC membership interest appears difficult to justify. Indeed, the potential ability to use limited liability companies as vehicles for selectively defeating the state apportionment and allocation formulas as applied to multistate corporate activities through the interposition of an LLC or LLP subsidiary has already received considerable attention. See ABA Tax Section Panel Explores Evolving Policy Toward LLCs and LLPs, State Tax Notes, August 12, 1996, pgs. 480-482. Of particular interest is the discussion of the issue of whether a state can tax a non-resident individual or corporate limited partner or holder of an LLC membership interest. But see Mary Lee Herman, Sup. Ct. Fulton County CAE-25101-25104, January 18, 1975 [Georgia has jurisdiction to tax non-resident limited partner on partners distributive share of income].

  5. Withholding.

    In large measure to anticipate and address these problems, many states have imposed withholding obligations with respect to distributions to non-resident owners of S Corporations, Partnerships or Limited Liability Companies. Georgia is among those with the adoption in 1993 of O.C.G.A. § 48-7-129 and the Regulations thereunder. Particularly noteworthy in the case of the Georgia statute is the imposition of a penalty on the distributing entity and its owners for failure to withhold on the applicable distributions. The Regulations Reg. 560-7-8-.34 are particularly important because of the detailed guidance they give, not only on the withholding rules, but also on apportionment and allocation issues affecting multistate partnership activities and the determination of the computation of the partnership’s Georgia based income. Additional valuable information on this subject appears in the booklet on this issue published by the Department, including valuable questions and answers.


  6. Composite Returns.

    As discussed above with respect to S Corporations, composite returns are often a practical way for multistate compliance by multistate flow through entities. In Georgia, composite returns are permissive for partnerships. Availability of a composite return is limited to partners who have no other Georgia source income. Thus, a non-resident partner which has income from other Georgia sources is not includable in a composite return and is subject to withholding tax. See Reg. §560-7-8-.34(3)(d)
 

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