Effective date: January 1, 2009
What is it? New regulations1 issued by the Massachusetts Department of Revenue (DOR) require “pass-through” entities that maintain an office or engage in business in the Commonwealth to withhold personal income taxes and corporate excise taxes on behalf of non-resident members2. A pass-through entity is one whose income, losses, deductions, and credits flow through to its members for Massachusetts tax purposes. Common pass-through entities include general partnerships, limited partnerships, limited liability partnerships, limited liability companies, “S” corporations, and estates and trusts not taxed at the entity level. Beginning in January 2009, unless a pass-through entity or its non-resident members are exempted (as described below), it will be required to withhold tax from each non-resident member’s share of income earned in Massachusetts.
What do you need to do? Massachusetts is one of many states recently to implement pass-through entity withholding. Entities with partners or members in other states will have to pay attention to these new regulations.
In Massachusetts, required withholding payments must be made quarterly. The amount that must be withheld annually is calculated by multiplying the withholding rate by the lesser of 80 percent of the member’s distributive share for that particular year or 100 percent of the member’s prior year distributive share. Each quarter, one fourth of this amount must be paid on or before the last day of the month following the close of the quarter. Additionally, an entity must file an annual withholding report with the DOR and provide a statement of amounts withheld and paid on the member’s behalf to each member subject to such withholding.
Who is exempt? Not all pass-through entities are required to withhold taxes for their non-resident members. The following categories of entities are exempt:
1. Investment Partnerships: an investment partnership is exempt if it is a partnership or limited liability company that satisfies the following: (a) substantially all of the entity’s assets consist of investment securities, deposits at banks or other financial institutions, or office equipment and office space reasonably necessary to carry on the activities of an investment partnership; (b) substantially all of the entity’s income is from interest, dividends, and capital gains; and (c) the entity is not engaged in a trade or business in Massachusetts.
2. Pass-through Entities That are Members of Another Withholding Entity: a member pass-through entity is exempt if it can demonstrate that the pass-through entity of which it is a member has already withheld all of the taxes it would have been required to withhold. For example, if Partnership A is a member of Partnership B, which has withheld sufficient income tax for Partnership A, there is no requirement that Partnership A also withhold taxes so long as it can show that Partnership B has already done so. In order to prevent withholding at multiple levels, a member pass-through entity that does not claim exemption and recognizes income may subtract from amounts to be withheld amounts withheld by the entity of which it is a member.
3. Others: a pass-through entity is exempt from withholding tax on a member’s pro-rata income if the member is certified as exempt by the DOR. One key class of exempt members are non-residents who either (i) participate in composite returns filed by the pass-through entity, or (ii) file a certification with the pass-through entity stating that they agree to file tax returns, make quarterly estimated tax payments, and accept personal jurisdiction in Massachusetts state courts for the determination and collection of taxes. Additional exempt classes of members include: (a) federally tax-exempt members, (b) Massachusetts residents that are individuals, estates, or trusts, (c) corporations that are subject to Massachusetts corporate tax laws and are filing a return, and (d) pass-through entities with a usual place of business in Massachusetts.
What is the penalty for not complying with the withholding requirements? If a pass-through entity fails to meet the withholding requirements, both it and its non-resident members may be subject to penalties including fines up to $100,000, as well as possible imprisonment. In addition, if the amount withheld for a member is less than the estimated taxes on all of its income, the member may be liable for interest and penalties.
What if a non-resident member has not filed tax returns in Massachusetts in the past? Non-resident members who have not filed Massachusetts tax returns in the past may consider Massachusetts’s voluntary disclosure program, which helps non-filing individuals and entities retroactively comply with filing requirements. Under this program, non-resident individual taxpayers and corporations or other entities outside of Massachusetts can voluntarily disclose their past non-filing with a “voluntary disclosure agreement.” The DOR will then limit its assessments to the three most recent years in which there was a failure to file. Without this exception, the DOR may assess a non-filing taxpayer for the most recent seven years of non-payment.
1830 CMR 62B.2.2
2A “member” of a pass-through entity includes a shareholder of a corporation; a partner in a partnership, including a limited partner in a limited partnership and a partner in a limited liability partnership; a member of a limited liability company treated as a partner under Massachusetts tax law; and a beneficiary of an estate or trust.
This advisory was prepared by Nutter’s Tax Department. For more information, please contact Melissa McMorrow or your Nutter attorney at 617-439-2000.
Circular 230 Disclosure: To ensure compliance with IRS Circular 230, we inform you that any federal tax advice included in this communication is not intended or written to be used, and it cannot be used, for the purpose of (i) avoiding the imposition of federal tax penalties or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.
This update is for information purposes only and should not be construed as legal advice on any specific facts or circumstances. Under the rules of the Supreme Judicial Court of Massachusetts, this material may be considered as advertising.