Corporate Close-Up: Arkansas Adopts Entity-level Apportionment for Partnerships, Conforming Law to Practice

Recent Arkansas legislation (H.B. 1562, enacted March 14, 2017) requires partnerships with income both within and outside the state to apportion income to Arkansas under the Uniform Division of Income for Tax Purposes Act, as adopted by the state. This requirement takes effect in tax years beginning on or after Jan. 1, 2018.

The intent of the legislation is to simplify tax reporting requirements for multistate partnerships, according to an Arkansas Department of Finance and Administration legislative impact statement. Under current law, partnerships must allocate their taxable income to Arkansas by separately identifying the states where items of income and expense are properly attributable. The department found that partnerships operating in multiple states struggle to allocate taxable income “because of the difficulty in assigning a transaction that benefits the entire partnership to a particular state.”

Although, before the legislation, Arkansas required multistate partnerships to separately account for and allocate income to the state, “this requirement was honored in the breach as most returns determined Arkansas income using formulary apportionment,” said Matthew C. Boch, member of Dover Dixon Horne PLLC in Little Rock and co-author of Bloomberg BNA’s Arkansas Corporate Income Tax Navigator. Going forward, the legislation “conforms the law to what has been common compliance practice of apportionment at the partnership level,” Boch said.

By requiring partnership-level apportionment, Arkansas takes an “entity” approach to partnership taxation and treats a partnership as a separate entity distinct from its partners. A nonresident corporate partner is taxed on its distributive share of the partnership income separately apportioned to Arkansas by the partnership. If the corporate partner also carries on its own business in Arkansas independent of the partnership’s activities, the corporation computes its own Arkansas income and adds to the result its share of the partnership’s Arkansas income.

Arkansas’ approach is in contrast to the “aggregate” or “flow-through” approach followed by most states. When reporting income to these states, a nonresident corporate partner aggregates its distributive share of the partnership’s income from all states with its own business income. The corporation then apportions its total business income using an apportionment formula that combines the corporation’s own apportionment factors with its distributive share of the partnership’s apportionment factors. In a state that takes the aggregate approach, the partnership’s apportionment factors flow up to corporate partners.

Although the Arkansas legislation mandates partnership-level apportionment, income apportioned to the state by the partnership will continue to be allocable for the partners. Partnership income and factors will not flow up for apportionment at the partner level. Because Arkansas continues to be an outlier among the states, Boch said that he expects to see businesses making mistakes complying with Arkansas tax on income from pass-through entities.

The legislation also allows a multistate partnership to request permission from the Department of Finance and Administration to use an alternative apportionment method, and grants the department authority to require use of an alternative method, if the Arkansas standard apportionment formula does not fairly represent the extent of the partnership’s business activity in the state. An alternative method may involve separate accounting, the exclusion of one or more apportionment factors, or the inclusion of one or more additional factors that will fairly represent the partnership’s business activity in Arkansas.

Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn: What impact, if any, will the requirement that partnerships filing an Arkansas return apportion income at the entity-level have on a nonresident corporate partner’s Arkansas tax liability?

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