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S Corp Composite Payments


Corduroy Frog

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Please let me ramble, and when I post something that is wrong, jump on me...

  • S Corporations operating in every state effectively create a liability for the owners in the various states.
  • This liability can be absolved by the corporation making a "composite" payment on behalf of the owners.  The rates are usually at a maximum, but the objective is to pay off the state so the owners don't have to file a non-resident return.  Owners are happy, and the states are happy to get maximum $$ without processing a return.
  • The composite payment constitutes a dividend/distribution on the books of the S corp, and is thus not deductible expense for the S Corp.
  • As being charged as dividends, the owners should be able to deduct the composite payment somewhere.  However, state income taxes are a Schedule A deduction, and the benefit may be lost because the standard deduction is so large, or lost because of the SALT.

If the S Corp cannot deduct the payment, and the owners cannot deduct the payment, then how can it be deducted?  Seems like it should be deductible somewhere...

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You are mostly correct as far as your points about the SALT limitation, but the payment made on behalf of the individual owner where a composite is not filed does have to opportunity to include the taxes paid in the calculation of itemized deductions vs the standard where it may be possible to gain some benefit if that owner hasn't already exceeded the limit and is itemizing. Also, there are more things consider if you are advising and preparing the S corp returns, and especially if there is more than one owner.

The operation in nonresident states to create a liability isn't an absolute given, but has the *potential* to do so. Filing a composite return may yield a higher tax overall than if filing individually because not all owners may be in the highest bracket in the state, especially if operating in states having graduated rates, and the individual owner may possibly be able to utilize other deductions or exclusions.

Some reasons why filing individually rather than using a composite return may be better:

  • the individual may be able to have some of that payment refunded that the passthrough made on his/her behalf, 
  • the individual will also be able to claim a credit on the personal resident state return for taxes paid to other states, and
  • if the individual's return has other items of deductions or losses that factor into AGI, filing individually may yield a lower state tax than the composite return at the highest rate in that state

Not meant to be all-inclusive as I'm sure I missed some points, but here are some other considerations in deciding to file individually:

  • If the passthrough has more than one owner, composite payments made for only those that are nonresidents may violate the company's operating agreement as to making equal distributions for all if there are owners or partners that are actually residents of some states, so cash payments may be required to some owners to make sure that distributions are equal for all, especially in S corps where unequal distributions are prohibited;
  • Some owners may have other income from those nonresident states, so the benefit of the composite return is negated or is to the detriment (see the point above about credit for taxes paid to other states);
  • Owners move, so there may be times when an owner is a part-year resident of two of the states where the company operates;
  • Owners with potential nexus or domicile issues in a particular state should carefully consider whether or not to file composite returns on his/her behalf because the statute of limitations does not start in that state if no individual return is filed;
  • Composite filing at the company level does not allow the individual taxpayer to choose between MFJ or MFS, if there may be some benefit to doing so for a particular state.

 

 

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9 minutes ago, cbslee said:

I have never heard of composite payments ? Is this real or hypothetical?

It's real.  The passthrough entity can file a composite state return on behalf of all nonresident shareholder's or partners as a group, and then the individuals are relieved of the filing requirement in that state if they have no other income there. 

 

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18 minutes ago, cbslee said:

This sounds like something totally different than PTET

It is different. There are 18 states that allow composite filings, and at this time only six of those have approved PTET filings and two more have proposals in the works, matching up the states listed in Lion's link above. The other 13 states with PTET never allowed composite filings, your state of OR being one of those.

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That article is about PTET, Pass Through Entity Tax, written shortly after IL enacted their PTET, so much of the article is from the perspective of IL's PTET. CT has had a PTET for a few years -- mandatory. NY's PTET begins in 2021 -- opt-in deadline for 2021 was 15 October 2021. There are some classes out there now; Tax Practice Pro did a live webinar that's now posted as on-demand: https://taxpracticepro.teachable.com/?page=3

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Judy's knowledge and research is always top-notch. As she explained, when a PTE has an option to file a composite return on behalf of its owners &/or the owners have an option to opt-in to a composite return, there are a lot of factors to consider if your client is the company or if your client is one of the owners. And, the new and rapidly expanding into more and more states PTET, sometimes mandatory and sometimes opt-in, is just one consideration.

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On 10/22/2021 at 11:41 PM, jklcpa said:

Not meant to be all-inclusive as I'm sure I missed some points

There can also be extra record keeping, such as when the pass thru entity is accrual and members are cash basis.

The whole idea is to save tax preparation cost by filing at the entity level vs individuals, so there has to be some cost analysis.

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