Tax Guide for Pass-Through Entity Withholding

This guide was developed to address questions pertaining to tax withholding compliance by pass-through entities.

This guide will help pass-through entities determine:

• Whether they should be withholding tax on distributive share amounts allocated to their members, and
• How much to withhold.

* For purposes of this guide, the term “member” shall generally refer to a partner in a partnership, a shareholder in an S-Corporation, a members of a limited liability company, trustees of certain trusts, and any other individuals with an ownership interest in a pass-through entity subject to withholding.

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. Pass-through entity withholding is authorized under General Laws Chapter 62B, § 2.

We hope that you find this guide helpful and urge you to contact our call center at (617) 887-6367 or (800) 392-6089 (toll-free in Massachusetts) if you need further assistance.

The pass-through entity withholding rules allow members of a pass-through entity subject to withholding to choose how they'll meet their Massachusetts tax obligations. These members can meet their obligation by:

• Agreeing to file and to subject themselves to personal jurisdiction in Massachusetts;
• Participating in a composite return filed by the pass-through entity; or
• Authorizing the pass-through entity to withhold and pay tax on their behalf.

Pass-through entities are required to report to DOR how each of their members plans to comply with these requirements, which are more fully explained below. 

A pass-through entity is an entity whose income, loss, deductions, and credits flow through to members for Massachusetts tax purposes.

The following are all pass-through entities:

• 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.

The following are considered members if they hold a beneficial interest in a pass-through entity:

• Partners
• Owners
• Shareholders, or
• Beneficiaries.
   

The following members are generally exempt from pass-through entity withholding:

• Massachusetts resident individuals
• Most Massachusetts estates and trusts
• Federally tax-exempt organizations
• Corporations subject to Massachusetts taxing jurisdiction that file returns, which include their distributive shares received from the pass-through entity
• Pass-through entities that are filing their own Massachusetts tax 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.

Member-Filed Return

Individual members of a pass-through entity may certify to the pass-through entity that they agree to:

• File any required Massachusetts tax returns on their own 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.

These members aren’t subject to withholding by the pass-through entity.

Pass-Through Entity Excise 

In response to the federal limitation on the state and local tax deduction imposed on individuals, Massachusetts enacted General Law Chapter 63D, which provides for an elective excise on pass-through entities. As a result, partnerships, S corporations and certain trusts may elect to pay a 5% excise on the amount of their income that is subject to the Massachusetts personal income tax at the individual partner, shareholder, or beneficiary level. Qualified members of the electing entities are allowed a personal income tax credit for 90% of their pro rata share of the excise paid by the pass-through entity. See TIR 22-6.   

For purposes of the pass-through entity excise, a “qualified member” is defined to include a natural person, estate or trust that is subject to the Massachusetts personal income tax and that is a shareholder, partner or beneficiary of a pass through entity that elects to file and pay the pass through entity excise.  

Composite Return

As an alternative to withholding on members, the pass-through entity may file a composite return on behalf of its individual nonresident members. To participate, the members must be nonresidents for the entire tax year.

The composite return will meet their filing and payment obligations as to their Massachusetts-source income from the pass-through entity.

Members may not claim deductions, exemptions, or credits on the income reported on the composite return.

Note:  If a pass-through entity files a composite return, and elects to pay the pass-through entity excise under  General Laws Chapter 63D, qualified members of the pass-through entity are allowed a personal income tax credit for 90% of their pro rata share of the pass-through entity excise paid with the composite return. For purposes of the pass-through entity excise, a qualified member is a shareholder of an S corporation or a partner in a partnership, including a member of a limited liability company that is treated as an S corporation or partnership that is a natural person or trust or estate subject to income tax in Massachusetts. See TIR 22-6.

Members who choose to participate in a composite return may have other Massachusetts source income in addition to their pass-through entity income. 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 aren’t subject to withholding by the pass-through entity filing the composite return.

Withholding

Members who have not certified to the pass-through entity that they agree to file their own tax return reporting the pass-through entity income, have not elected to participate 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.
 

Certain pass-through entities are exempt from pass-through entity withholding:

• Certain investment partnerships,
• Trusts and estates subject to withholding on nonresidents under another Massachusetts provision,
• 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, and
• Publicly traded partnerships.

Another type of entity exempt from pass-through entity withholding is an entity that is prohibited under federal or state law from withholding tax from distributions to members. An example of this related to some for-profit entities that provide low-income housing and receive funding through MassHousing or the United States Department of Housing and Urban Development. This exemption applies only for years in which distributions are prohibited under federal or state law. Contractual restrictions on distributions, such as loan covenants or organizational documents, do not qualify an entity for this exemption.

Exemption Certificates 

Pass-through entities are required to obtain and keep certificates from members claiming exemption from withholding. Any member that wishes to be treated as exempt from withholding must generally provide to the pass-through entity a certificate of exemption on or before the last day of the fourth month of the entity's taxable year.  If the member’s status changes during the tax year, the entity must obtain a new certificate within 30 days of the date the member’s status changes. 

See more about exemption certificates below.

Providing Information

A pass-through entity that isn't exempt must file all returns electronically, and report information 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,
• Other type of corporation or unincorporated business entity, etc.

At the end of the Schedules 3K-1 and SK-1, the pass-through entity will indicate how the member is meeting his/hers/its tax obligation. Space is provided to indicate:

• Amounts withheld or
• That the member has paid as part of a composite filing.

Withholding on non-exempt members.

If withholding is required, the pass-through entity must:

• Register for pass-through entity withholding
• Make quarterly payments of amounts withheld, and
• File an annual withholding return, Form PTE-WH, with DOR.

All of the above must be done online through MassTaxConnect. Form PTE-WH is due March 31^st for calendar year filers and must be filed to reconcile previous payments even if no payment is due.

Withholding Amounts

Pass-through entities are required to withhold an amount that is calculated based on Massachusetts taxable amounts of distributive share allocated to a member subject to withholding. The amount subject to withholding is calculated based on the entity’s Massachusetts-source income. The entity must notify each member of the amount withheld or paid on the member's behalf on the Schedule 2K-1, Schedule 3K-1, or Schedule SK-1, as appropriate.

Apportionment

Pass-through entities with income from sources both within Massachusetts and elsewhere must allocate and apportion the income to determine the proper withholding amount, according to the provisions of the Pass-Through Entity Withholding Regulation, 830 CMR 62B.2.2. For non-resident taxpayers who are subject to tax under the personal income tax provisions of M.G.L. c. 62, pass-through entities are required to apportion according to the rules in the Non-Resident Income Tax regulation, 830 CMR 62.5A.1. With respect to corporate partners, pass-through entities should apply the apportionment rules in the Apportionment of Income regulation, 830 CMR 63.38.1.  

Determining Withholding Amount; Safe Harbor

A pass-through entity must make an annual payment on behalf of each member subject to withholding. The amount of payment due is determined by multiplying the withholding rate by the lesser of

•           80% of each member's distributive share for the taxable year, or

•           100% of each 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. If the member is a pass-through entity, the withholding entity should use the individual tax rate for Part B taxable income.

The withholding rate for corporations is the applicable tax rate under chapter 63.

The total paid by the pass-through entity is the sum of the tax on the annual allocation of the distributive share made on behalf of each member subject to withholding. A pass-through entity required to withhold that doesn't 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. For example, the withholding rate for individuals and pass-through entity members 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.

The following can be netted in determining distributive share:

• Income
• Gain
• Loss
• Deductions and
• Credits, including a qualified member’s credit for his or her share of the pass-through entity excise paid by the pass-through entity.

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 obligation is 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.

All payments must be made using ACH Debit on MassTaxConnect.

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 close of the entity's taxable year, showing the total amount withheld for the taxable year.  All non-exempt pass-through entities must file this return, even if no tax was withheld; in such cases the pass-through entity will report zero tax withheld on the form.   

Member's Estimated Tax Payment

A member may reduce his/hers/its own estimated payment by amounts previously paid by the pass-through entity on the member's behalf. Individuals and corporations have statutory estimated payment obligations that aren’t replaced by pass-through entity withholding.

A corporation, for example, is required to make an estimated payment of 40% of its required annual payment by the 15^th day of the 3^rd 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 member.

In calculating the amount due in an estimated payment, a member 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 member's tax year, as of the date of receipt by the Department.

A pass-through entity's withholding payment could meet a member's estimated payment obligation on the member'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
• Schedule SK-1 if the entity is an S corporation, or
• Schedule 2K-1 if the entity is an estate or trust.
   

Member's Tax

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 Qualified members may also claim a credit of 90% of the pass-through entity excise paid by the pass through entity.

Definition of Tiered Structure

A tiered structure is a pass-through entity that has at least one pass-through entity as a member.

The pass-through entity that is the member is the upper-tier entity. The entity of which it is a member is the lower-tier entity. 

A tiered structure can have any number of tiers.

Pass-Through Member Compliance in a tiered structure

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 its income hasn’t previously been subject to withholding.

If an upper-tier 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 upper-tier entity's withholding obligation.

Each upper-tier entity must pass information about amounts withheld to its own members.

Filing requirements

A pass-through entity that derives income that is taxable in Massachusetts, whether from

• The conduct of a trade or business or

• The ownership of real or tangible personal property in Massachusetts,
   

must file a withholding return in Massachusetts, unless it is exempt as described above. Please refer to all current electronic filing requirements on the Department’s website.

In a tiered structure, the distributive share of income that an upper-tier entity receives from a lower-tier entity, which derives income from Massachusetts sources is considered to be derived from Massachusetts sources. Accordingly, the upper-tier entity must file a Massachusetts withholding return.

The activities of a pass-through entity are attributed to its members. An upper-tier entity is therefore engaged in the activities of the lower-tier 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 withholding return in Massachusetts including any income from the lower-tier entity, the lower-tier entity won't be required to withhold on the upper-tier entity.

An upper-tier entity may influence the lower-tier entity's withholding treatment if the upper tier entity:

• Certifies to the lower-tier entity that it is tax-exempt under Internal Revenue Code section 501, and that all its distributive share from the lower-tier entity will be exempt from Massachusetts tax;
• Certifies 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;
• Certifies to the lower-tier entity that because all of its members are exempt from withholding, the lower-tier entity doesn’t 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
• Communicates the names, addresses, and federal identification numbers or social security numbers of all 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 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, 2K-1, and/or SK-1.
   

Upper-tier entity obligations

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, in accordance with Massahusetts withholding rules.

Amounts withheld by all lower tiers on behalf of a member for the taxable year must be summed and reported on the members' Schedule 3K-1, 2K-1, and/or SK-1.

Special S-Corporation Rules

A lower-tier entity that is an S-corporation must have the same tax year as any upper-tier entity for withholding purposes. Either:

• The upper-tier entity and the lower-tier S corporation must align their taxable years so that the lower-tier entity can withhold, or
• The upper-tier entity must certify that it will be filing its own return.

Most trustees of trusts and estates are subject to withholding on their nonresident beneficiaries under specific statutory provisions outside of the Pass-through entity withholding statute. Trustees that are subject to such specific rules are generally exempt from the rules for pass-through entity withholding that are found in this guide, as are their beneficiaries. For example, trusts and estates that are required to withhold or make estimated payments for nonresident beneficiaries under M.G.L. c. 62, § 10(g), including nonresident grantors of grantor trusts, are not subject to, nor required to withhold, under the pass-through entity withholding rules in this guide, nor are their beneficiaries. Additionally, trustees of Individual Retirement Accounts or other retirement funds making payments subject to federal withholding rules under section 3405 of the Internal Revenue Code and thus to the withholding rules under M.G.L. c. 62B, § 2, also aren’t subject to the rules in this guide. See 830 CMR 62B.2.1(4)(d) and 830 CMR 62B.2.2(3)(b)2.

A trustee or beneficiary of an exempt trust, estate, or retirement account is also exempt from pass-through entity withholding if that entity is part of a tiered structure. 

While many trusts are exempt from pass-through entity withholding, as described above, there are some trusts that are subject to pass-through entity withholding.  For example, 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.

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 expects 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 change in status. 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.

Example:

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 Massachusetts resident with Profitable Partnership on January 12^th. 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 15.

Example:

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 15 that he has moved and tells the partnership that he is no longer exempt from withholding. Profitable Partnership will withhold income taxes on Peter's distributive share for the last two quarters of its taxable year.

Completing exemption certificates for certain entities

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 fund qualified under section 584 of the Internal Revenue Code that is treated as a partnership for Massachusetts tax purposes should fill 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:

• Fill the box that reflects the owner's circumstances, and

• Enter the owner's Federal Taxpayer Identification Number or Social Security Number.

Limited Liability Company. A Limited Liability Company that is treated as a partnership for Massachusetts tax purposes should fill the appropriate box on the Form PTE-EX as a pass-through entity.

A Limited Liability Company that is treated as a corporation for Massachusetts tax purposes should check the appropriate box on the Form PTE-EX as a corporation.

S-Corporation. An S-Corporation completing the Form PTE-EX should fill the appropriate box as a pass-through entity. It shouldn’t fill any box available to corporations.

Individual nonresident limited partners of a securities partnership

Individual nonresident limited partners of a limited partnership that are 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).

If a partnership is engaged in a "trade or business" other than buying, selling, dealing in or holding securities on its own behalf and not as a broker, it does 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 nonresident individual's income is not subject to Massachusetts tax.

As noted in the “Pass-through Entities Exempt from Withholding” section above, pass-through entities with legal limitations on distributions aren’t required to withhold for years in which distributions are prohibited under federal or state law.  However, these entities are required to withhold in any year that the entity is permitted to make a distribution.

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 pass-through entity and made available upon request.

The letter claiming exemption should be signed by a responsible person and must be 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

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,
• 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.

Rules for nonresidents checking 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 fill 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.

Entity withholding 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.

Composite Returns

Filing composite returns and making estimated payments

Composite returns must be filed electronically. Estimated payments for composite returns must also be made electronically. Further information about composite returns and payments may be found on the Department's website.

The difference between composite return estimated payments and pass-through entity withholding

Composite payments of estimated tax are due on the dates that individual estimated payments are due:  

• April 15^th
• June 15^th
• September 15^th and
• January 15^th of the following tax year.

Composite payments are payments of estimated tax on behalf of the qualified electing nonresidents, 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 doesn’t replace a taxpayer's estimated payment obligation.