Uniformity Committee Fall Meeting – November 9, 2021
The MTC held its Uniformity Committee Fall Meeting on November 9. During the meeting, MTC staff presented the Partnership Project’s issues outline and provided a status update. The presentation consisted of a general overview of the project’s history, an analysis of the issues outline, a discussion on the project’s survey results, and the proposal of a project roadmap and next steps.
The Partnership Project’s long-term goal is to analyze each issue set forth in the outline in detail, in order to determine whether the states would benefit from model statutory language. One of the project’s more imminent next steps involves the creation of MTC-sponsored trainings on federal partnership taxation. It is not clear whether such trainings will be available to the public sector, or which area of state partnership taxation will be dealt with first.
During the meeting, both state and business representatives communicated their respective industries’ interest in continuing to pursue the project.
Sixth Meeting – October 26, 2021
MTC staff will present an issues outline during the MTC’s November 9 Uniformity Committee Meeting. On October 26, the MTC held a final Partnership Project meeting, focusing on administrative and enforcement issues as well as a discussion of the survey results.
With respect to the administrative and enforcement issues existing in partnership taxation, MTC staff highlighted three topics: withholding, pass-through entity taxes and audit procedures and adjustments.
The current MTC withholding model does not address procedures for withholding proceeds from sales of a partnership interest, as the federal rules for foreign partners now require. According to MTC staff, those states that impose withholding requirements typically do so in the context of distributive share income and guaranteed payments, but not for sales of a partnership interest.
Moreover, MTC staff highlighted that pass-through entity taxes are generally imposed on income derived within the state (whether the partners are residents or not) and sourced under general sourcing rules applied at the entity level. There are, however, differences in the way such taxes have been implemented by each state, as well as each state’s audit and adjustment procedures.
During the last portion of the meeting, MTC staff went over the state survey results, noting that jurisdiction, nexus, sourcing and credits tied as the most important issues in the realm of partnership taxation. The current order of the issues outline aligns with subject matter importance, according to the survey results. In addition, the taxation of partnership income and sales of partnership interest were voted as the subjects for which training would be most valuable.
Eversheds Sutherland attorneys plan to attend the November 9 meeting and provide timely updates thereafter.
Fifth Meeting – October 5, 2021
MTC staff resumed their discussion on sourcing the sale of partnership interests, considering administrative and enforcement issues in the area of partnership taxation.
During the discussion of the sale of partnership interests, which begun last week, MTC staff considered federal treatment of such sales under IRC § 741. The statute provides that gain or loss from the sale of a partnership interest is treated as a capital asset, unless overridden by IRC § 751. States generally conform and source the sale of a partnership interest as an intangible. In spite of this, state adjustments to the “outside basis” are not uniform.
As foreshadowed in previous meetings, states source the gain (or loss) arising from the sale of a partnership interest differently—some states look at the partnership’s assets to determine the sourcing methodology, whereas other states look at individual partners activities, or the partner’s domicile.
The fifth meeting also covered administration and enforcement issues. MTC Staff highlighted the importance of reporting by providing examples of serious repercussions that arise because of insufficient enforcement. The meeting wrapped up with a brief discussion on withholding; while most states have some form of withholding, the methods and exceptions employed by each state vary.
Fourth Meeting – September 28, 2021
MTC staff resumed the discussion on the two methods used when sourcing partnership income: situs-based sourcing and apportionment-based sourcing. MTC staff recognized that situs-based sourcing is especially appealing for states when the state lacks nexus over the partner or the income in question, as well as when the income is nonbusiness income in the hands of the partner. The issues outline includes a section on sourcing income from investment partnerships, even though only a minority of the states have specific treatment for investment partnerships.
With respect to apportionment-based sourcing, MTC staff highlighted that additional complications arise when the states take into account the type of partner—that is, whether the partner is a managing partner, general partner, limited partner, et cetera. As an example, MTC staff stated that some states treat limited partners differently than general partners. MTC staff disagreed with this conclusion, explaining that “limited partners” are limited only with respect to their liabilities and the type or label of a partner should not be indicia of their involvement in the partnership’s business. Moreover, there is little authority for treating partners differently in other areas of state partnership taxation.
MTC staff also focused on two topics: credits for taxes paid, and sale of partnership interests. The discussion on credits was brief—MTC staff acknowledged that states do not credit partnership taxes in the same way.
In contrast, the discussion on sale of partnership interests was lengthy. Existing case law was highlighted, which suggests that: (1) the existence (or lack thereof) a unitary relationship is the turning point in determining whether the gain may be taxed by a state, and (2) if a due process connection exists with respect to the partnership’s operating income, there should be sufficient nexus for the state to tax any gain resulting from the sale of the partnership interest.
Third Meeting – September 14, 2021
On September 14, 2021, the MTC held its bi-weekly meeting for the Partnership Project. The discussion started with MTC staff acknowledging that no U.S. Supreme Court case has addressed the application of general sourcing rules, or formulary apportionment, to partnership operating income taxed on a pass-through basis. As a result, MTC staff looked to the application of general constitutional principles as applied to partnership taxation.
As with other areas of the outline for the Partnership Project, the partnership’s attributes will determine how the constitutional principles are applied. For example, consider a hypothetical Partnership “AB” formed by Partner A and Partner B. Partner A lives in State 1 and Partner B lives in State 2; both State 1 and State 2 use single sales factor apportionment. Partnership AB produces 90% of its sales in State 2. In addition to its share of partnership items, Partner A receives a guaranteed payment for services done for the partnership—entirely in State 1. Under federal partnership rules, this guaranteed payment would reduce partnership income. Modeling a uniform way to treat guaranteed payments, however, is not an easy endeavor. Conflicting interests amongst the states threaten uniformity; this predicament exists in most areas of state partnership taxation.
MTC staff provided other examples to highlight the potential challenges that exist in applying constitutional principles to state partnership taxation. The examples provided by Ms. Hecht demonstrate that differences in the partnership or partner’s information as well as the selected approach to sourcing may lead to very different results.
Second Meeting – August 31, 2021
On August 31, 2021, the MTC held another Partnership Project meeting. During the meeting, MTC staff went over two issues: first, the implications that arise from conformity with the federal partnership rules; and, second, the importance of sourcing partnership income.
When evaluating the potential issues in conforming to the federal partnership rules, MTC staff highlighted themes that could disrupt uniformity amongst the states, including: (1) guaranteed payments for partners of a partnership, (2) deductible partnership expenses, (3) offsetting income and loss from other partnerships or sources, and (4) anti-abuse rules to prevent abusive tax planning. During the discussion of the fourth item, MTC staff acknowledged that the MTC has a disclosure model that would apply to the Partnership Project.
The second topic of the meeting, sourcing of partnership income, touched on the importance of sourcing partnership income for state tax purposes. Using a diagram and data from the Outline, MTC staff demonstrated that a state could tax anywhere from 0 to 100% of a partnership’s income, depending on which sourcing approach is used. Five different types of sourcing methods were considered for this hypothetical illustration: (1) situs-based sourcing based on the partnership’s location, (2) situs-based sourcing based on partner location, (3) apportionment-based sourcing based on partnership location, (4) apportionment-based sourcing based on a corporate partner’s location, and (5) apportionment-based sourcing using a combination of the partnership and the corporate partner’s apportionment factors.
First Meeting – August 17, 2021
On August 17, 2021, the MTC held its first meeting of the Partnership Project, during which the work group discussed a draft outline of partnership issues. The Partnership Project is being chaired by Laurie McEhatton (California Franchise Tax Board) and staffed by Helen Hecht (General Counsel at the MTC).
As an introduction, MTC staff (Hecht) provided an overview of the Partnership Project. The project’s first step is the creation of an outline that identifies and describes a list of comprehensive issues existing in the area of state partnership taxation. Thus far, the current draft is divided into four sections: (1) General Terminology, (2) Taxation of Partnership Income and Items; (3) Taxation of Gain (Loss) from Sales of a Partnership Interest; and (4) Administrative Enforcement. MTC staff reiterated that the outline is a working draft, and ongoing changes will be made to the outline as the Partnership Project advances.
MTC staff then went into a more in-depth discussion of the first and second sections of the outline (General Terminology and Taxation of Partnership Income and Items). First, the discussion of the General Terminology section consisted of an overview of certain terms defined in the outline. Given that each state interprets terms differently, uniform definitions/understanding of concepts will be imperative for the Partnership Project’s success. Next, with respect to the second section of the outline, jurisdiction, nexus and sourcing were discussed. Specifically, MTC staff noted these issues vary significantly amongst the states, and each state has its own rules to determine the partnership tax base. Thus, the Partnership Project will consider ways in which the states can achieve uniformity as it relates to these matters.
Digging Deep: a discussion and update on two MTC uniformity projects
On August 12, 2021, Helen Hecht, Uniformity Counsel at the MTC joined host and Eversheds Sutherland Partner Nikki Dobay for an episode of the SALT Shaker Podcast policy series. Helen and Nikki engaged in a discussion of the Partnership Project. Listen to the podcast here.
On June 15, 2021, the Multistate Tax Commission (MTC) held an introductory meeting to discuss the State Taxation of Partnerships Project (the Partnership Project). The work group intends to focus on the “underdeveloped” state partnership tax rules and provide guidance and structure in the state partnership taxation realm. The Partnership Project will hold bi-weekly meetings, and Eversheds Sutherland SALT attorneys plan to attend all meetings and provide timely updates.
The work group focused on an issue outline drafted by MTC staff that contemplates areas where state partnership taxation rules either differ from one another or lack specificity. Based on feedback received from the states and the MTC Standing Subcommittee, the issue outline is divided into three general categories: (1) issues related to taxing partnership income, (2) issues related to gain or loss on the sale of a partnership interest, and (3) administration and other issues.
- Issues Related to Taxing Partnership Income. The issue outline discusses the states’ conflicting jurisdictional rules that affect administrative obligations imposed on partnerships. Similarly, it discusses the confusion regarding nexus rules for nonresident and corporate partners as well as how the factor presence nexus standard might apply. In addition, the outline notes that the states have distinct sourcing and apportionment rules, exceptions and exemptions, transfer pricing statues and state income adjustments that should be contemplated in pursuit of uniformity, and the working group’s discussion seemed to hone in on the need for guidance in the transfer pricing area.
- Issues Related to Gain or Loss on Sale of a Partnership Interest. The issue outline acknowledges that nexus is considered when determining whether a state can tax gain or loss on the sale of a partnership interest. Likewise, the outline notes that sourcing and reporting rules regarding the sale of partnership interest could be harmonized.
- Administration and other Issues. The issue outline concludes that the states’ rules lack guidance on the application of tax credits for partnership income, centralized audits and the functionality of the state and local tax deduction cap.
The Partnership Project’s goal is to finalize an outline and present it to the MTC Uniformity Committee.