| Date: | 04/17/2003 |
|---|---|
| Referenced Sources: | Massachusetts General Laws |
Personal Income Tax
You have requested a letter ruling on behalf of two entities, *************** (Corporation) and *************** (Partnership), for permission for each entity to file a separate composite return for its respective shareholders and partners.
The taxpayers have made the following representations of fact on which we base this ruling.
a. Corporation
Effective January 1, 2002, Corporation elected to be treated as an S Corporation for federal income tax purposes and will file Massachusetts Form 355S for the tax year ended December 31, 2002. Prior to the S election, Corporation was a C Corporation and filed Form 355 in Massachusetts. Corporation will continue to file its own return and does not seek permission to join in the composite return.
Corporation is commercially domiciled in Illinois. Corporation has 75 trust shareholders, each of which elected to be treated as an Electing Small Business Trust (ESBT) under I.R.C. § 1361(e). Each trust shareholder is a non-resident of Massachusetts. As a result of the S Corporation election, each of the trust shareholders will be responsible for filing a return and remitting tax to Massachusetts for their share of Massachusetts source income. Each ESBT has a separate tax identification number. Each ESBT includes in its income its pro rata share of income. Fifty-three of the 75 trust shareholders have no Massachusetts source income apart from their distributive share of Corporation's income. The remaining 22 trust shareholders have Massachusetts source income from both the Corporation and the Partnership, and no other Massachusetts source income. With one exception all beneficiaries of the trust shareholders have no Massachusetts source income other than that of the Corporation or Partnership.
b. Partnership
Partnership is a limited partnership with one corporate general partner and 22 limited partners that are complex trusts. The general partner files its own return and does not seek permission to join in the composite return. The 22 complex trusts are part of the group that elected to be treated as ESBTs for purposes of reporting their income from the Corporation. The corporate general partner and each limited partner are non-residents of Massachusetts. If filing the composite return is permitted, the limited partners will pay tax in Massachusetts on their entire Massachusetts source earnings, both distributed and undistributed, as well as all Massachusetts source capital gains distributions to the trusts. With one exception all beneficiaries of the trust partners have no Massachusetts source income other than that of the Corporation or Partnership.
1. You request permission to report the Massachusetts source income of the 75 trust shareholders of the Corporation on a composite return.
2. You also request permission to report the Massachusetts source income of the trust limited partners of the Partnership on a separate composite return. These eligible trust limited partners will thus report their Partnership income and their income from the Corporation on two separate composite returns.
1. The Corporation will be permitted to file a composite return on behalf of the 75 non-resident trust shareholders that have Massachusetts source income. This permission is granted on the condition that all Massachusetts source income of the shareholders is reported on one or more composite return(s), and that all other requirements of the non-resident income tax regulation are met.
2. The Partnership will be permitted to file a composite return on behalf of the 22 trust limited partners, all of which will have income reported on the composite return described in Ruling 1. This permission is granted on the condition that all Massachusetts source income of the partners is reported on one or more composite return(s), and that all other requirements of the non-resident income tax regulation are met.
a. The general rule for filing composite returns.
Under the non-resident income tax regulation, partnerships and S-corporations are permitted to file composite returns as an agent for their qualifying non-resident partners or qualifying non-resident shareholders if they meet certain eligibility criteria. 830 CMR 62.5A.1(12)(f), (g). A qualifying electing non-resident partner or shareholder must meet the following criteria: the partner or shareholder must be an individual or the estate or trust of a deceased non-resident partner; the partner or shareholder must be a non-resident for the entire taxable year; the partner or shareholder must have no other Massachusetts source income nor may the partner's or shareholder's spouse have other Massachusetts source income, if they are filing jointly; the partner or shareholder must elect to be included in the composite return, and the partner or shareholder cannot file a separate Massachusetts return; and, the partner or shareholder must waive the right to claim deductions, exemptions, and credits allowable under G.L. c. 62, §§ 3, 5, and 6. 830 CMR 62.5A.1(12)(f)(1), (2). Partners included in a composite return must have the same taxable year, which generally will be the calendar year. See 830 CMR 62.5A.1(12)(f)(3).
b. Issue: May a trust that receives income from the Corporation or the Partnership be a qualifying non-resident shareholder or partner eligible for participation in a composite return?
(1) Are the ESBT shareholders of the Corporation eligible for participation in the filing of a composite return?
One of the qualifying requirements for participating in a composite return of an S-Corporation is that its shareholders be individuals. The Corporation's shareholders are ESBTs. The Department has ruled that although an ESBT is not an individual nor the estate or trust of a deceased individual, an ESBT has tax attributes similar to an individual, and may be treated as an individual for purposes of electing to join in the filing of a composite return. LR 98-19. See I.R.C. § 641(c). Like an individual, an ESBT has a separate tax identification number and includes in income its pro rata share of the S Corporation income. Under the Internal Revenue Code (the Code), that portion of an ESBT's income that is derived from an interest in an S corporation is taxed to the ESBT rather than to the beneficiary, at the highest rate applicable to trusts. I.R.C. § 641(c)(1), (2). For Massachusetts purposes, the income of the ESBT is taxed to the trust at the same rate it would be if the taxpayer were an individual. G.L. c. 62, § 10(a). Permission to file a composite return will have no effect on the amount of tax paid by the shareholders. Accordingly, the Department will treat the ESBTs of the Corporation as qualified electing non-resident shareholders, eligible to participate in the filing of Corporation's composite return, provided all other criteria are met within the meaning of 830 CMR 62.5A.1(12)(f), (g), and in accordance with Ruling 2. Specifically, all Massachusetts source income of the Corporation must be reported on the composite return.
(2) Are the trust partners of the Partnership eligible for participation in the filing of a composite return?
The limited partners of the Partnership are not ESBTs for the purpose of reporting their share of partnership distributions. Rather, they are complex trusts, that is, trusts that may accumulate income or distribute corpus. See generally I.R.C. §§ 661-664. At the federal level, distributions from complex trusts are taxed to the beneficiary; the trust pays tax only on undistributed income and gains. See I.R.C. §§ 661-662. For Massachusetts purposes, however, complex trusts are treated exactly as ESBTs are treated. Massachusetts source income received by a non-resident fiduciary is taxed at the trust level. G.L. c. 62, § 10(a). The same income is not taxed to the beneficiary. Id. See also Form 1-NR/PY, Instructions, Schedule E, Part III.
The complex trusts have tax attributes similar to an individual. They have separate tax identification numbers and pay tax on their pro rata share of partnership distributions. Permission for the limited partners to participate in the filing of a composite return will have no effect on the amount of tax paid by the Partnership. Accordingly, the Department will treat the trust limited partners of the Partnership as qualified electing non-resident partners, eligible to participate in the filing of Corporation's composite return, provided all other criteria are met within the meaning of 830 CMR 62.5A.1(12)(f). Specifically, all Massachusetts source income of the Partnership must be reported on the composite return. This result accords with permission granted a partnership to file a composite return in LR 01-10.
c. Issue: Is it proper to report the income of those beneficiaries that receive income from both the Corporation and the Partnership on separate composite returns?
The 22 limited partners of the Partnership are also shareholders in the Corporation. Permission to allow both the Partnership and the Corporation each to file a composite return will result in those 22 limited partners having income reported on both returns. The regulation requires that to be a qualified electing non-resident partner eligible to participate in the filing of a composite return, the partner must have no other Massachusetts source income, nor may it file a separate return. 830 CMR 62.5A.1(12)(f)(1)(c), (d).
The Department interprets the phrase "no other Massachusetts source income," as used in 830 CMR 2.5A.1(12)(f)(1)(c) to mean no Massachusetts source income other than income reported on one or more composite returns. See LR 98-13. The requirement that the partner may not file a separate return means that it may not file an individual return reporting its own income. The 22 limited partners may report their income from the Corporation on the Corporation's composite return, and may report their income from the Partnership on the Partnership's composite return. This permission is granted only to the extent that the income reported on these two composite returns represents all of the Massachusetts source income of the limited partners, and that all other requirements of 830 CMR 62.5A.1(12)(f) are met.
d. Issue: Does it matter that an individual beneficiary of one of the trusts has other Massachusetts source income?
Under the non-resident income tax regulation, eligibility for non-residents to participate in a composite return requires that the partner must have no Massachusetts source income besides that reported on the composite returns. 830 CMR 62.5A.1(12)(f)(1)(c). In reviewing this case, the Department has learned that one beneficiary of the trust shareholders/partners has Massachusetts source income other than that of the Corporation or Partnership. We have determined that the source income of the beneficiary is immaterial to this ruling. It is not the beneficiary that is joining in the composite return, but rather the trust. By this ruling, the Department acknowledges that permission for the trusts to join in a composite return is based on the fact that the trusts themselves have tax attributes similar to individuals, and the trusts themselves do not have any Massachusetts source income other than that to be reported on the composite returns.
More specifically, the beneficiary that has other Massachusetts source income will file a separate return and pay the tax due on the income that is not reported on the composite returns. The difference in tax effect is that the trusts that join in the composite returns are denied the deductions, exemptions, and credits allowable under G.L. c. 62, §§ 3, 5, and 6. 830 CMR 62.5A.1(12)(f)(1)(e). The individual beneficiary filing a separate tax return will therefore not receive those benefits on income it receives from the trusts, but the beneficiary may be entitled to those benefits for the other Massachusetts source income that is not reported on the composite returns.
One purpose of the regulation allowing the filing of composite returns on behalf of non-resident partners in a partnership and of non-resident shareholders in an S corporation is to lessen the administrative burden of both taxpayers in preparing returns and the Department in processing them. Another is to ensure that all required taxes are paid. The provisions of the non-resident income tax regulation are designed to effect these goals. The regulation ensures that all income can be traced to its recipient, and that all taxes are paid on all Massachusetts income. You have demonstrated that filing one composite return for the 75 shareholders of the Corporation and another for the 22 trust limited partners of the Partnership will accomplish this goal. All Massachusetts source income of the trust shareholders of the Corporation and trust partners of the Partnership will be reported on one or more composite returns. The Department therefore grants permission to file these two composite returns, provided that all other requirements of the regulation are met.
Very truly yours,
/s/Alan LeBovidge
Alan LeBovidge
Commissioner of Revenue
AL:DMS:dt
LR 03-1
