Updated March 4, 2016
This guide was developed to address questions pertaining to tax compliance by pass-through entities and their members. In particular, this guide will help pass-through entities with Massachusetts-source income determine whether they should be withholding tax on distributive share amounts allocated to their members, and if so, how much to withhold. The goal of pass-through entity withholding is the same as the goal of wage withholding: to withhold an amount that is substantially equivalent to the tax amount reasonably estimated to be due. The program, authorized under chapter 262, § 21 of the Acts of 2004, is in effect for tax years beginning on or after January 1, 2009. We hope that you find this guide helpful and urge you to contact us directly if you need further assistance.
Description of the Program
For tax years beginning on or after January 1, 2009, Massachusetts has adopted new mechanisms for pass-through entities and their members to comply with Massachusetts tax laws. The pass-through entity compliance program allows members of pass-through entities subject to this program to choose how they will meet their Massachusetts tax obligations. The compliance program also requires pass-through entities to report to DOR how their members plan to comply.
The pass-through entity compliance program allows non-exempt members of pass-through entities subject to this program to meet their tax obligation by: agreeing to file and to subject themselves to personal jurisdiction in Massachusetts; participating in a composite return by the pass-through entity; or having the pass-through entity withhold and pay tax on their behalf. These three options are explained more fully below. The compliance program generally exempts the following members: Massachusetts resident individuals, most Massachusetts estates and trusts; federally tax-exempt organizations; corporations subject to Massachusetts taxing jurisdiction filing their returns including any distributive share from the pass-through entity; pass-through entities that are filing a return; and insurance companies. To be treated as exempt by the pass-through entity, these members must file an exemption certificate (Form PTE-EX) with the pass-through entity.
What is a pass-through entity?
A pass-through entity is an entity whose income, loss, deductions and credits flow through to members for Massachusetts tax purposes. General partnerships, limited partnerships, limited liability partnerships, limited liability companies with members treated as a partner under Massachusetts tax law, S corporations, estates not taxed at the entity level, and trusts not taxed at the entity level are all pass-through entities. Partners, owners, shareholders, or beneficiaries of a pass-through entity are called "members."
What are the tax compliance options for non-exempt members of a pass-through entity?
Member-Filed Return. Individual members of a pass-through entity who agree to file may certify to the pass-through entity that they agree to file any required Massachusetts tax returns for their income subject to tax in Massachusetts, make their own quarterly estimated tax payments if required, and accept personal jurisdiction in Massachusetts state courts for the determination and collection of taxes. Members who elect this compliance method will be responsible for filing and paying on their own behalf. These members are not subject to withholding by the pass-through entity.
Composite Return. Members of a pass-through entity who are non-resident individuals may elect to have the entity make estimated payments and file a tax return on their behalf. Members who choose to participate in a composite return may have other Massachusetts-source income in addition to their pass-through entity income. The composite return will meet their filing and payment obligations as to their Massachusetts-source income from the pass-through entity. These members may not claim deductions, exemptions, or credits on the income reported on the composite return. These members will file a separate tax return for any income not covered in a composite return. Members electing to participate in a composite return are not subject to withholding by the pass-through entity filing the composite return. See more on composite filing below.
Withholding. Members who have not agreed to file, have not participated in a composite return, or have not certified that they are otherwise exempt from withholding, will be subject to withholding on their distributive share by the pass-through entity, unless the entity itself is exempt from having to withhold.
Which pass-through entities are exempt from having to withhold?
Certain pass-through entities are exempt from participation in the withholding program. Specifically, certain investment partnerships, trusts and estates subject to withholding on nonresidents under another Massachusetts provision, and upper-tier pass-through entities that can prove that a lower-tier pass-through entity has previously withheld and made payments of all Massachusetts tax are not required to withhold under this program. Pass-through entities that are prohibited under federal or state law from making tax payments on behalf of their members are not required to withhold under this program for a year in which distributions, including distributions to pay taxes, are prohibited. See "How should pass-through entities with legal limitations on distributions comply?" below. See "How should certain limited partners comply with the pass-through entity withholding program?" for compliance by limited partners in certain limited partnerships.
What must pass-through entities do to comply with the withholding program?
Obtain and keep certifications from members claiming exemption from withholding. Any member that wishes to be treated as exempt from withholding must generally submit a certification of exemption on or before the last day of the fourth month of the entity's taxable year, or within 30 days of joining the entity. The entity must keep this certification on file and produce it upon the Commissioner's request. See more about exemption certificates below.
Provide information regarding each member. A pass-through entity that is not exempt must file all returns electronically. Information must be filed for each member. As part of the electronically filed Schedule 3K-1 and SK-1 forms, the pass-through entity will be asked to provide information identifying the member as an individual resident or nonresident, trust or estate, S-corporation, corporation, etc. At the end of the Schedules 3K-1 and SK-1, the pass-through entity will indicate how the member is meeting the member's tax obligation. Space is provided to indicate amounts withheld or paid as part of a composite filing. Similar information is required on the Schedule 2K-1. No other annual schedule of information regarding members is required .
Withhold on non-exempt members. If withholding is required, the pass-through entity must register, make quarterly payments of amounts withheld, and file an annual withholding return with the Commissioner. Registration, payment, and the annual withholding return must all be filed electronically on the Department's website, using MassTaxConnect.
Notify members subject to withholding of the amount that has been withheld on their behalf. The entity must notify each member of the amount withheld or paid on the member's behalf on the Schedule 2K-1, 3K-1 or SK-1 as appropriate.
How does a pass-through entity register for pass-through entity withholding?
Pass-through entities must register for pass-through entity withholding and make required payments via MassTaxConnect.
How should a pass-through entity determine withholding? Is there a safe harbor?
A pass-through entity must make an annual payment on behalf of each member subject to withholding. For each member subject to withholding, the pass-through entity must pay an amount calculated by multiplying the withholding rate by the lesser of 80% of the member's distributive share for the taxable year, or 100% of the member's prior year distributive share. This calculation provides the entity's minimum withholding "safe harbor." The withholding rate for individuals, estates, or trusts is the tax rate imposed on Part B taxable income. The withholding rate for corporations is the applicable tax rate under chapter 63. If the member is a pass-through entity, the withholding entity should use the individual tax rate for Part B taxable income. The total paid by the pass-through entity is the sum of the tax on the annual allocation of distributive share made on behalf of each member subject to withholding. A pass-through entity required to withhold that does not meet its withholding obligation is subject to the penalties under chapter 62B and chapter 62C.
In calculating the amount to withhold, the pass-through entity will apply a single withholding rate to the member's distributive share for the taxable year. Income, gain, loss, deductions and credits may be netted in determining distributive share. The withholding rate for individuals and member pass-through entities is the tax rate imposed on Part B taxable income, even though some of the distributive share may ultimately be subject to a different rate of tax. Amounts withheld may not be sufficient to meet the individual's estimated payment obligation; as a result, the individual may be required to make estimated payments to ensure that sufficient amounts have been timely paid.
The annual payment shall be paid in four quarterly installment payments of 25% of the total amount. Each quarterly payment is due on or before the last day of the month following the close of the quarter of the entity's taxable year. Quarterly payments must be made using ACH Debit on the Department's website. After the taxable year ends, the withholding pass-through entity will electronically file a "Pass-Through Entity Annual Withholding Tax Return," on or before the last day of the third month of the year following the taxable year, showing the total amount withheld for the taxable year. If no tax was withheld, the form should be filed showing zero tax withheld. The withholding application is available at www.mass.gov/dor.
How do members take credit for amounts withheld and paid on their behalf?
Member's Estimated Tax Payment
A member may reduce, by amounts previously paid on the member's behalf, the member's own estimated payment. Individuals and corporations have statutory estimated payment obligations that are not replaced by withholding by a pass-through entity. A corporation, for example, is required to make an installment payment of 40% of its required annual payment by the 15th day of the 3rd month of the taxable year. This required payment is due earlier, and in a higher fraction of the annual payment, than the pass-through entity withholding requirement for that taxpayer.
In calculating the amount due in an estimated payment, a taxpayer may take account of an amount previously withheld and paid to the Commissioner by the pass-through entity on behalf of the member, applicable to the entity's taxable year ending within or with the taxpayer's tax year, as of the date of receipt by the Department. A pass-through entity's withholding payment could meet a taxpayer's estimated payment obligation on the taxpayer's distributive share if the pass-through entity accelerates the timing and amount of withholding sufficiently to meet its members' estimated payment obligations.
During the taxable year, the pass-through entity is responsible for communicating amounts withheld to the member. After the taxable year is closed, this information must be reported on the Schedule 3K-1 if the pass-through entity is treated as a partnership, or on the Schedule SK-1 if the entity is an S corporation, or on the 2K-1 if the entity is an estate or trust.
A member may claim credit on the member's tax return for the amount withheld by the pass-through entity on behalf of the member that is applicable to the member's taxable year.
How do tiered structures comply with the new requirements?
What is a tiered structure?
A tiered structure is a pass-through entity that has a pass-through entity as a member. (The pass-through entity that is the member is the upper-tier entity; and the entity of which it is a member is the lower-tier entity.) A tiered structure can have any number of tiers.
Are members that are themselves pass-through entities subject to the compliance program?
Yes. The obligation to withhold begins with the lowest-tier entity that has Massachusetts-source income. Regarding its members that are pass-through entities, the lowest-tier entity must either obtain certifications of exemption or withhold. An upper-tier entity may have its own withholding obligation regarding Massachusetts-source income if the income has not previously been withheld upon. If the member entity has no Massachusetts-source income other than its distributive share of income from the lower-tier entity, the lower-tier entity's withholding will be sufficient to meet the member entity's withholding obligation. Each member entity will pass information about amounts withheld to its own members.
A pass-through entity that derives income from a Massachusetts source, whether from the conduct of a trade or business or from the ownership of real or tangible personal property in Massachusetts, must file a return in Massachusetts. In a tiered structure, the distributive share of income that an upper- tier (member) entity receives from another pass-through entity deriving income from Massachusetts sources is considered to be derived from Massachusetts sources; accordingly, the upper tier entity must file a Massachusetts return. The activities of a pass-through entity are attributed to its members; an upper-tier pass-through entity is therefore engaged in the activities of the lower-tier pass-through entity. This is true regardless of the number of tiers of pass-through entities between the lowest tier of the entity structure and the highest tier. If the upper-tier entity certifies to the lower-tier entity that it will be filing its own return in Massachusetts including any income from the lower-tier entity, the lower-tier entity will not be required to withhold on the upper-tier entity.
How may an upper-tier entity influence the lower-tier entity's withholding treatment?
1. Certify to the lower-tier entity that it is tax-exempt under Internal Revenue Code section 501, and that all of its distributive share from the lower-tier entity will be exempt from Massachusetts tax;
2. Certify to the lower-tier entity that because it will be filing its own return including any distributive share from the lower-tier entity, it is exempt from the withholding requirement;
3. Certify to the lower-tier entity that because all of its members are exempt, the lower-tier entity does not have to withhold on the upper-tier entity's distributive share (the upper-tier entity should be able to produce its members' exemption certificates at the Commissioner's request); or
4. Communicate the names, addresses, and federal identification numbers or social security numbers of all of the upper-tier's members to the lower-tier entity so that the lower-tier entity can withhold directly upon the upper-tier's members. The lower-tier entity may accept copies of exemption certificates filed with the upper-tier entity in lieu of withholding on those members. This arrangement is at the discretion of the lower-tier entity. Requests for such treatment are made on the withholding exemption certificate form, copies of which must be retained by both the upper-tier and the lower-tier entities. The amount withheld must account for tax applied to the entire taxable distributive share transferred from the lower-tier entity to the upper-tier entity. The lower tier entity must communicate amounts withheld to the upper-tier entity for inclusion on the members' Schedules 3K-1 or SK-1.
What obligations does an upper-tier entity have after a lower-tier entity has withheld on it?
The upper-tier entity is responsible for allocating to its members the amount withheld on its behalf by the lower-tier entity. The sum of the withheld tax allocated to the upper-tier entity's members must equal the amount withheld on the upper-tier entity's distributive share from the lower-tier entity. If the upper-tier entity has additional Massachusetts-source income, it may be required to withhold additional amounts, following the withholding rules. Amounts withheld by all lower tiers on behalf of a member for the taxable year must be summed and reported on the member's Schedule 3K-1 or SK-1.
How should income be apportioned for withholding purposes if the tiered structure is not in a unitary business?
If the lower-tier entity is not engaged in a unitary business with the upper-tier entity, the lower-tier entity should apportion income to Massachusetts based on its own apportionment factors. If withholding is required, it should withhold, at the appropriate rate, on each member's distributive share as that share is determined under the partnership agreement.
The distributive share of any pass-through entity retains its character as it passes through the structure, whether that income or loss comes from the conduct of a trade or business, or from the ownership of real or tangible personal property in Massachusetts. In a tiered structure consisting of multiple pass-through entities, including non-Massachusetts businesses that are engaged in a unitary business, the income is apportioned to Massachusetts as a unitary business, taking into account the factors of all components of the group. In other words, the entire income derived from the related activities of the members of the unitary business is subject to Massachusetts apportionment. The proper unitary business apportionment is calculated based on the pro rata share of the factors of each entity in the unitary structure, aggregated for the entire group. All pass-through entities in the unitary business should withhold using the apportionment percentage of the unitary business. For more information, see 830 CMR 62.5A.1(6).
Yes. A lower-tier entity that is an S-corporation must have the same tax year as any member pass-through entity for withholding purposes. The member pass-through entity and the lower-tier S-corporation must either align their taxable years so that the lower-tier entity can withhold, or the member pass-through entity must certify that it will be filing its own return.
How should trusts, estates, and trustees of retirement funds comply with withholding or estimated payment obligations?
Trusts and estates that are required to withhold or make estimated payments on payments to nonresidents under M.G.L. c. 62, § 10(g), including grantor trusts, are not required to withhold under the pass-through entity withholding program. Trusts and estates that have no nonresident beneficiaries, but would be subject to the withholding or estimated payment requirements of §10(g) if they had any nonresident beneficiaries, are not subject to the pass-through entity withholding program. In either case, these trusts and estates should indicate on the Form 2 or 2G that they are subject to trust and estate withholding or estimated payment requirements. Beneficiaries of trusts and estates and grantors of trusts subject to trust and estate withholding or estimated payments do not need to submit the Form PTE-EX to the trust or estate.
Trusts and estates required to withhold on Massachusetts residents under M.G.L. c. 62, § 11A must withhold on nonresident beneficiaries under the pass-through entity withholding program, because M.G.L. c. 62, § 11A makes no withholding provisions for nonresident beneficiaries. Accordingly, trustees of pooled income funds, charitable remainder annuity trusts or charitable remainder unitrusts must withhold on their nonresident beneficiaries unless those beneficiaries certify, on the Form PTE-EX, that they are exempt from withholding.
Trustees of retirement funds, such as Individual Retirement Accounts or other retirement funds making periodic or nonperiodic payments, are subject to federal withholding rules under section 3405 of the Internal Revenue Code. Withholding of Massachusetts income tax by the trustee is required under G.L. c. 62B, section 2, as explained in 830 CMR 62B.2.1(4)(d), if the recipient has elected federal income tax withholding. Since these trusts and custodial accounts are subject to the withholding rules of 830 CMR 62B.2.1, they are not required to participate in pass-through entity withholding. See 830 CMR 62B.2.2(3)(b)2.
A trust, estate, or retirement account that is an upper-tier entity in a tiered pass-through entity structure must be withheld upon as a member of a lower-tier pass-through entity unless it submits an exemption certificate (Form PTE-EX) to the lower-tier pass-through entity indicating that it will be filing any required return in Massachusetts and making any required estimated tax or withholding payments. Trusts and estates subject to M.G.L. c. 62, § 10 (g), to M.G.L. c. 62B § 2, or to the pass-through entity withholding program may complete the Form PTE-EX to exempt themselves from being withheld upon as a member of a pass-through entity. Trusts and estates paying tax at the entity level may also complete the exemption certificate. The Form PTE-EX certifies that the trust, estate, or custodial account will be filing any required return, reporting any distributive share, and making any required estimated tax or withholding payment. Once signed and submitted to the lower-tier entity, the certification remains in effect until revoked by the trust, estate, or custodial account.
When must exemption certificates be filed?
A member must file an exemption certificate (Form PTE-EX) with the pass-through entity on or before the later of the last day of the fourth month of the entity's taxable year or within 30 days of the member joining the entity. The pass-through entity will retain all certificates filed with it, according to the record retention rules of 830 CMR 62C.25.1, for possible review by the Commissioner. A pass-through entity that reasonably expected to have no Massachusetts-source income during the taxable year may obtain exemption certificates from its members within 30 days of the first date the pass-through entity could reasonably foresee that it would realize Massachusetts-source income. A member whose reason for a withholding exemption changes must file a new exemption certificate within 30 days of the date the member's status changes. A member who no longer qualifies for an exemption from withholding must notify the pass-through entity within 30 days of the date the member's status changes. A taxpayer's signed Form PTE-EX will remain in effect until revoked by the taxpayer; annual filing is not required. A pdf version of Form PTE-EX may be downloaded and printed from the DOR website, www.mass.gov/dor.
Peter Partner is exempt from withholding because he is a resident of Massachusetts. Peter is a member of Profitable Partnership, which operates on a calendar year. Peter files an exemption certificate indicating that he is a resident with Profitable Partnership on January 12th. On July 1, Peter moves to New Hampshire. He decides that he will agree to file and be subject to Massachusetts jurisdiction, and files a new exemption certificate with Profitable Partnership so indicating on July 15th.
Same facts as above, except that Peter decides to let Profitable Partnership withhold on his behalf after he moves to New Hampshire. He notifies Profitable Partnership on July 15th that he has moved and tells the partnership that he is no longer exempt from withholding. Profitable Partnership will withhold on Peter's distributive share for the last two quarters of its taxable year.
The following entity types, if they choose to execute exemption certificates, should identify themselves according to these instructions. Generally, an entity should identify itself according to its entity classification for Massachusetts tax law purposes.
Common trust under c. 62, § 17(e). A common trust treated as a partnership for Massachusetts tax purposes should check the appropriate box as a pass-through entity.
Disregarded entity. An entity that is disregarded for Massachusetts tax purposes is also disregarded for purposes of the Form PTE-EX. The owner of the disregarded entity should check the box that reflects the owner's circumstances, and enter the owner's FID or SSN.
Limited Liability Company. A Limited Liability Company that is treated as a partnership for Massachusetts tax purposes should check the appropriate box as a pass-through entity. A Limited Liability Company that is treated as a corporation for Massachusetts tax purposes should check the appropriate box as a corporation.
S-Corporation. An S-Corporation completing the Form PTE-EX should check the appropriate box as a pass-through entity. It should not check any box available to corporations.
Individual nonresident limited partner of a securities partnership. An individual nonresident limited partner of a limited partnership that is engaged exclusively in buying, selling, dealing in or holding securities on its own behalf and not as a broker, as described in M.G.L. c. 62, § 17(b), whose distributive share of income from the pass-through entity will not be taxable in Massachusetts, may comply with the pass-through entity withholding program by indicating on the Form PTE-EX that he or she agrees to file any required tax returns, make quarterly estimated payments as required, and accept personal jurisdiction in Massachusetts state courts (individual box 3). (Such partnerships may in some circumstances be engaged in a "trade or business" and thus not meet the definition of "investment partnerships" exempt from withholding under the pass-through entity withholding regulation.) No Massachusetts return is required to be filed if the non-resident individual's income is not subject to Massachusetts tax.
Corporate nonresident limited partners qualifying for the securities partnership exception under 830 CMR 63.39.1(8)(b) or the de minimis exception under 830 CMR 63.39.1(8)(d). A corporate nonresident limited partner of a limited partnership that is engaged exclusively in buying, selling, dealing in or holding securities on its own behalf and not as a broker, as described in 830 CMR 63.39.1(8)(b), is not subject to tax in Massachusetts on the income from the limited partnership. A corporate nonresident limited partner of a limited partnership that meets the de minimis exception of 830 CMR 63.39.1 (8)(d) is not subject to tax in Massachusetts on the income from the limited partnership. A corporate nonresident limited partner of a limited partnership that will not, under the corporate nexus regulation, 830 CMR 63.39.1(8)(b) or (d), be subject to the corporate excise in Massachusetts on its distributive share of income from the pass through entity, may comply with the pass-through entity withholding program by indicating on the form PTE-EX that it is a corporate limited partner in a limited partnership, exempt from tax under 830 CMR 63.39.1 (8)(b) or (d), and not a member of a combined group with members subject to Massachusetts tax jurisdiction. If the corporation is exempt from tax under 830 CMR 63.39.1 8(b) or (d) but is a member of a combined group with members subject to Massachusetts tax jurisdiction, it should so indicate on the form PTE-EX.
How should pass-through entities with legal limitations on distributions comply?
Pass through entities with legal limitations on distributions are not required to withhold for years in which distributions are prohibited under federal or state law. Pass-through entities that are permitted to make distributions to pay taxes must participate in the withholding program in any year in which such distributions are permitted. If distributions to pay taxes are permitted in some years but not others, a pass-through entity must participate in years in which distributions to pay taxes are permitted. A pass-through entity that is permitted to make distributions to pay taxes in a subsequent year based on a prior year's distributive share must comply with the withholding requirements in the year in which distributions are made with respect to the prior year's distributive share (i.e., catching up on the deferred withholding), as well as withholding for the current year on any current year distributive share. For each year it claims to be exempt from the withholding requirement, a pass-through entity must send a letter to the Massachusetts Bureau of Desk Audit stating that it has not withheld because distributions to pay taxes are prohibited under federal or state law for that tax year. Further, for the exemption to be effective, documentation supporting the exemption claim must be retained by the entity, and made available upon request. The letter claiming exemption should be signed by a responsible person; the signature will not be considered valid unless it is accompanied by a statement that the letter is signed under the penalties of perjury. The due date for the letter is the same as the due date for the entity's annual return. The letter should be sent to: Massachusetts Department of Revenue, 200 Arlington Street, Room 4300, Pass-Through Exemptions, Chelsea, Massachusetts, 02150.
What documentation is required from an individual non-resident participating in a composite return?
An individual nonresident who has filed a Composite Return Filing Statement (DOR Form CRFS, available on the DOR website) need not also file a Form PTE-EX, since the individual acknowledges, on the Form CRFS, that he or she has an obligation to file a return, make estimated tax payments if required, and pay his or her pro rata share of any penalty and interest due for any underpayment of estimated taxes, and, further, agrees to be subject to jurisdiction in Massachusetts. A Form CRFS filed with the pass-through entity in lieu of the Form PTE-EX must be filed according to the Form PTE-EX filing dates. An individual that elects not to participate in a composite return must file with the pass-through entity a Form PTE-EX within 30 days after his or her exemption status changes.
May non-residents who may not have a filing requirement check box 3 of the Form PTE-EX?
No Massachusetts return is required to be filed if income is below the personal exemption amount multiplied by the ratio of Massachusetts income to total income. (See the Department's Guide to Personal Income Taxes for more information.) An individual may check box 3 on the Form PTE-EX, agreeing to file tax returns in Massachusetts, whether or not a return is required in a particular year.
May an entity withhold on a member who has agreed to self-file?
If a member has filed an exemption certificate with the pass-through entity indicating an intention to self-file, the pass-through entity may nonetheless withhold on the member if the member and the entity agree.
What is the treatment of publicly traded partnerships?
Publicly traded partnerships are not required to withhold on their members. A publicly traded partnership is not required to report the method of compliance for its members.
Who may be included in a composite return?
As an alternative to withholding on members, the pass-through entity may file a composite return on behalf of its individual non-resident members. To participate, the members must be non-residents for the entire tax year.
How are composite returns filed and estimated payments made?
Composite returns must be filed electronically. Estimated payments for composite returns must be made through ACH Debit. Further information about composite returns and payments may be found on the Department's website, www.ma.gov/dor.
Are composite return estimated payments and pass-through entity withholding the same?
No. Composite payments of estimated tax are due on the dates that individual estimated payments are due, i.e., April 15th, June 15th, September 15th, and January 15th of the following tax year. Composite payments are payments of estimated tax on behalf of the qualified electing non-residents, and they fulfill the taxpayer's estimated payment requirement. Withholding payments, by contrast, are due on the last day of the month following the close of the entity's calendar quarter. A taxpayer may reduce his or her estimated payment obligation to take account of amounts withheld on the taxpayer's behalf, but pass-through entity withholding does not replace a taxpayer's estimated payment obligation.
How can I get more information?
You can get more information by visiting the DOR website at www.mass.gov/dor, or you can call DOR at 617-887-MDOR.