Keeping Pass-Through Earnings from Passing Through the State: Composite Returns and Withholding


As more and more interstate pass-through entities enter the business landscape, states have had to review their mechanisms for collecting tax from pass-through members who earn income attributable to the state. Two such mechanisms are composite returns, which allow pass-through entities to report and pay for their nonresident members’ income and tax, and withholding, which ensures that the tax owed to the state is retained by the in-state pass-through entity.

Thirty-eight states and the District of Columbia allow pass-through entities to make an election to file composite returns. However, Alabama, Connecticut, Indiana and Louisiana require pass-through entities to file a composite return for nonresident members. Nebraska, Oklahoma, Tennessee, Utah, and the District of Columbia do not accept composite returns at all.

While composite returns are mostly elective, withholding the tax these nonresidents may owe is generally not. Only 4 states require pass-through entities to file a composite return for nonresident members, but 37 states require that pass-through entities withhold income from nonresident entity members, although many states offer exemptions or only require withholding past a certain threshold.

Luckily, some states allow pass-through entities to file composite returns as an alternative to withholding taxes for nonresident members. This cuts down on the administrative burden of managing the tax liabilities of nonresident members.

See the chart below for further information on where the states stand on composite returns and withholding.

By Melissa Fernley

Follow us on Twitter at @BBNATax

Join BNA's State Tax Group on LinkedIn here .

States Requiring

Composite Returns

 

States Requiring Withholding

 

States Requiring Neither Composite Returns

Nor Withholding

Alabama

Connecticut

Indiana

Louisiana

Alabama

Arkansas

California

Colorado

Connecticut

Georgia

Hawaii

Idaho

Illinois

Indiana

Iowa

Kansas

Kentucky

Louisiana

Maine

Maryland

Massachusetts

Michigan

Minnesota

Mississippi

Missouri

Montana

New Jersey

New York

North Carolina

North Dakota

Ohio

Oklahoma

Oregon

Pennsylvania

Rhode Island

South Carolina

Utah

Vermont

Virginia

West Virginia

Wisconsin

Alaska

Arizona

Delaware

District of Columbia

Florida

Nebraska

New Hampshire

New Mexico

Tennessee

Texas