State & Local Tax
Flow-through
Illinois Steps Up Enforcement for Non-resident Shareholders, Partners and Members
February 2, 2007
Joe Roznai
Michael Silver & company
joer@msco.net
The Illinois Department of Revenue (IDOR) recently mailed a notice to both tax preparers and pass-through entities indicating that the Department will be stepping up it's compliance enforcement activity to Illinois non-resident recipients of income from pass-through entities, such as partnerships and S corporations, engaging in Illinois business activity. Based on this notice, and commentary by the Director of IDOR at the recent ICPAS/IDOR Practioners' Conference, it is apparent that Illinois is serious about cracking down on non-residents with Illinois source income through S Corporations and Partnerships.
In order to avoid the interest and most of the penalty that will be associated with potential Illinois tax notices, tax preparers need to ensure that applicable pass-through entities are made aware of the Illinois income tax filing obligations, and pass the information to their respective non-resident shareholders. There are two options:
- The Partnership or S Corporation can complete an Illinois Composite return to pay the tax for non-resident owners, and charge the tax against distributions as applicable.
- Each non-resident shareholder files their own respective Illinois non-resident income tax return.
Option (1) can be appealing, inasmuch as it is often less time-consuming and expensive to add the Composite Return schedule to the Illinois Corporation or Partnership income tax return than it is to prepare a separate Illinois Income tax return for each of the non-resident individuals. Under both Options, the non-resident should receive a credit against applicable resident state income tax for some or all of the income taxes paid to Illinois on the same income. (Obviously, there can be no credit for residents of states that do not impose an income tax).
Constitutionality of California LLC Annual Fee Being Challenged
Steven R. Goluch, CPA, MST
Wolowicki and Associates, LLC
steve@wolowicki.com
Key Highlight: Taxpayer’s who have paid LLC Fee may wish to file a protective claim for refund.
Under current law, LLC’s registered to do business in California are subject to an annual fee in California which is based on worldwide income without apportionment or allocation. The fee bears no relation to a taxpayer’s activity in the state. Recently, “Northwest Energetic Services” (Northwest) filed suit in San Francisco Superior Court challenging the constitutionality of the LLC Fee.
According to court documents, Northwest stated that other than registering to do business in the state, it did not conduct any business activity in the state between 1997 to 2001. By registering to do business in the state, Northwest became subject to California’s LLC fee which is imposed on the taxpayer’s worldwide income under California’s current tax rules. Northwest has paid the tax and is suing for a refund claiming the fee violates the Commerce Clause of the U.S. Constitution. The outcome of the lawsuit will have a direct impact on other similarly situated taxpayers.
If you have clients who had paid the LLC fee and their California source income was less than their income for all other sources, you may wish to file a “Protective Claim for Refund” based on the results of the Northwest case. The case, after appeals, could take years to decide and filing the protective claim will preserve your client’s right to a refund by suspending the statute of limitations for refund claims.
The taxpayer’s amended return must state at the top of the first page “PROTECTIVE CLAIM FOR REFUND BASED ON THE OUTCOME OF NORTHWEST ENERGETIC SERVICES.” In addition attach a statement to the return citing the case and explaining the issue. The FTB has advised that if these procedural steps are taken, the FTB will hold the claim until the case is resolved.
More details on the case can be found on the Court’s website at www.sftc.org and the case number is CGC-05-437721.