Composite State Income Tax Returns Should You Participate or Not?

Are you a partner, LLC member or an S corporation shareholder of a multi-state business or investment fund?  If so, you are probably familiar with filing non-resident state income tax returns.  Many of you may be choking on complications such
non-resident filing requirements add, as each state may require not just an annual tax return, but also estimated tax payments and the corresponding potential for more tax notices.

One option many states offer to reduce your paperwork burden is to participate in a composite state income tax return.

Composite tax returns shift the administrative burden of filing and paying state taxes for income earned by non-resident owners to the multi-state pass-through entity (“PTE”) versus the owner or investor.  Basically, a composite tax return is a group filing by some or all of the non-resident members of the PTE.  So, if this makes life easier for you, should you participate if the option is offered?

Maybe or maybe not!

First, a taxpayer has to meet the state’s requirements to participate in the composite tax return. 

Typically, to be able to participate in a composite tax return:

  • the income from the electing PTE must be your only income source from that state
  • you must not have been a resident of such state at any time during the year
  • you must have the same tax year (typically calendar year) as the PTE

Other limitations may apply as each state has its own rules.

You should be aware, however, that joining a composite tax return may cost you more in taxes!

Most states have adopted special rules concerning the computation of tax liability (within a composite filing) that differ from the normal rules of how to calculate personal tax liability.  Generally, participants in a composite tax return are taxed at the highest marginal tax rate applicable to individuals or at the applicable corporate tax rate.  States may also impose limitations on the availability of credits, net operating losses and deductions in composite returns.  Further, composite filings typically do not take into account personal exemptions, losses from other entities or itemized deductions.

The potentially higher tax liability in the non-resident state, however, may be partially offset by increased tax credits on your resident state income tax return.

Still, even with the potential for paying higher state income taxes, there are many advantages to participating in a composite tax return.  Remember that by participating in a composite tax return, you may significantly reduce your compliance burden by:

  • eliminating the need to file non-resident tax returns
  • avoiding the cost and complexity of complying with multiple state income tax rules
  • eliminating other compliance responsibilities such as estimated payments, and
  • shifting the burden of dealing with notices or audits to the entity.

So, if you are overburdened with paperwork from your non-resident filing requirements, see if your multistate PTE offers the option to participate in a composite state income tax return.

As always, if you have any questions about a composite tax return, please contact your local CBIZ MHM tax professional.

Copyright © 2011, CBIZ, Inc.  All rights reserved. Contents of this publication may not be reproduced without the express written consent of CBIZ. To ensure compliance with requirements imposed by the IRS, we inform you that-unless specifically indicated otherwise-any tax advice in this communication is not written with the intent that it be used, and in fact it cannot be used, to avoid penalties under the Internal Revenue Code, or to promote, market, or recommend to another person any tax related matter. This publication is distributed with the understanding that CBIZ is not rendering legal, accounting or other professional advice. The reader is advised to contact a tax professional prior to taking any action based upon this information. CBIZ assumes no liability whatsoever in connection with the use of this information and assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein.

CBIZ MHM is the brand name for CBIZ MHM, LLC, a national professional services company providing tax, financial advisory and consulting services to individuals, tax-exempt organizations and a wide range of publicly-traded and privately-held companies. CBIZ MHM, LLC is a fully owned subsidiary of CBIZ, Inc. (NYSE: CBZ).