Margin & Excise Taxes Paid by Partnerships May Not be Claimed as a Credit on a Partner's Individual Income Tax Return
February 03, 2012
This is a letter ruling issued by the Director of Revenue under Section 536.021.10, RSMo, and the Missouri Code of State Regulations 12 CSR 10-1.020, in response to your letter dated December 8, 2011.
The facts as presented in your letter ruling request are summarized as follows:
Applicant is a Missouri limited liability limited partnership that derives substantially all of its income through its ownership interest in a Missouri limited partnership. It operates and conducts business in all fifty states.
The majority of states allow partnerships flow-through treatment, by which state income is reported at the individual level and state income taxes are paid at the individual level by the partners of the Applicant. Missouri allows individuals to take a credit for the amount of income taxes paid to other states, when filing their Missouri income tax returns.
Certain states assess an entity level tax on the Applicant and/or the Missouri limited partnership. In that case, certain state income taxes are paid at the partnership level. The state of Washington assesses entity level taxes on the Applicant through its recently amended business and occupation (B&O) tax. The Texas margin (TM) tax also assesses entity level taxes. The Missouri limited partnership paid both the B&O tax and the TM tax during its calendar year ending December 31, 2010.
Will individual partners of Applicant be allowed to claim a credit on their Missouri individual income tax returns for their proportionate share of the TM tax paid directly by the limited partnership?
Yes. Individual partners of Applicant will be allowed to claim a credit on their Missouri individual income tax returns for their proportionate share of the TM tax paid directly by the limited partnership.
Section 143.401, RSMo, provides that in Missouri a partnership is not subject to income tax, but the individual partners are liable for paying the tax. The income of the limited partnership would pass through the Applicant down to the individual Missouri resident partners, and be taxed to those individuals under Section 143.401.
Many of the individual partners of the Applicant are residents of Missouri who are required to report their distributive share of the Applicant's income on their Missouri individual income tax returns. Section 143.081.1, RSMo, provides that a partner who is a Missouri resident individual is allowed a credit from his or her Missouri income tax for the amount of any income tax imposed on him or her for the taxable year by another state.
The TM tax is a tax on corporations and other business entities that do business in Texas. Limited and limited liability partnerships are taxed at the entity level. The tax is computed by determining the total revenue of the taxpayer using various revenue amounts reported on the taxpayer's federal income tax return. The taxable margin for the taxpayer is computed one of three ways: (1) total revenue times 70 percent; (2) total revenue minus cost of goods sold; or (3) total revenue minus compensation. Texas assesses the tax using varying tax rates.
In the case of Herschend v. Director of Revenue, 896 S.W.2d 458 (Mo. banc 1995), the Missouri Supreme Court found that the Tennessee excise tax was an "income tax" paid to another state which was creditable against Missouri income tax due. The Court in Herschend applied two tests, the "based on" test and the "object" test, to determine whether another state's tax is an "income tax" for which Missouri residents can take credit when computing their Missouri income tax for a given tax year.
The Herschend Court first analyzed whether the tax was "based on" federal taxable income. The Tennessee tax at issue in that case was based solely on federal taxable income and was calculated just like the Missouri income tax, at a fixed percentage of total income. Unlike the previous Texas excise tax analyzed by the court in Brennan v. Director of Revenue, 937 S.W.2d 210 (Mo. banc 1997), which included both an income and a capital component, the new TM tax based solely on various types of income reported on the federal income tax return. In this respect, the TM tax meets the "based on" test in Herschend and would be considered an income tax for purposes of the credit provisions in Section 143.081.1, RSMo.
The second test applied in Herschend is the "object" test. The TM tax is called a franchise tax. The "object" of a franchise tax is to impose a tax for the privilege of doing business in the state whereas the "object" of an income tax is to pay compensation for benefits, such as roads, police and fire protection that are provided by the state. The "critical distinction" between the operation of a tax as a franchise tax or as an income tax is that a franchise tax is payable in advance for the privilege of exercising the right to do business in the future, whereas an income tax is compensatory for benefits received and is due even if the corporate entity ceases to exist and discontinues doing business in the state. Herschend, 896 S.W.2d at 460. Although the TM tax is called a franchise tax, before a corporation doing business in Texas can dissolve, it must satisfy all tax liabilities. In other words, the corporation must pay the TM tax due even if the corporation ceases doing business in the state. The TM tax is a compensatory tax that "operates" as an income tax. Per the Herschend "object" test then, the TM tax is an "income tax" for the purposes of Section 143.081.1, RSMo.
Therefore, individual partners of Applicant are allowed to claim a credit on their Missouri individual income tax returns for their proportionate share of the TM tax.
Will individual partners of Applicant be allowed to claim a credit on their Missouri individual income tax returns for their proportionate share of the Washington B&O tax paid directly by the limited partnership?
No. Individual partners of Applicant will not be allowed to claim a credit on their Missouri individual income tax returns for their proportionate share of the Washington B&O tax paid directly by the limited partnership.
The B&O tax is an excise tax assessed on the gross receipts of corporations and other entities that do business in Washington. Limited and limited liability partnerships are taxed on the entity level.
The first test in Herschend is the determination of what the tax is "based on." The Court in Herschend noted that the Tennessee excise tax was based on "net earnings" which equated to "federal taxable income." The court noted that Missouri's income tax based on "Missouri taxable income" is also based solely on federal taxable income. Herschend, 458 S.W.2d at 459-460. The same does not apply to the B&O tax. The B&O tax is not "based on" federal taxable income, which is income net of various credits and deductions. The B&O tax is based on the gross income or gross receipts of businesses which operate in Washington.
The second test applied by the court in Herschend is the determination of the "object" of the tax at issue. In analyzing the "object" of the Tennessee excise tax, the Court in Herschend noted that although the Tennessee tax at issue was called an excise tax, the Tennessee statute made no reference to the privilege of doing business in the state. Herschend, 458 S.W.2d at 460. However, the "object" of the B&O tax is clearly defined in the Washington statutes as a state excise tax on businesses operating in Washington "for the act or privilege of engaging in business activities" in the state of Washington. West's RCWA 82.04.220.
The B&O tax meets neither of the Herschend tests for an "income tax." It is not a tax "based on" net income, and the "object" of the tax is to assess businesses for the "privilege of doing business" in Washington.
Since the B&O tax would not be considered to be an "income tax" in Missouri, individuals may not claim a credit based on that tax for Missouri income tax purposes. The individual partners of Applicant are not allowed to claim a credit for a proportionate share of the B&O tax on their Missouri individual income tax returns.
This letter ruling is binding upon the Department of Revenue with respect to the Applicant for three (3) years from the date of this letter and subject only to statutory changes by the General Assembly and to changes in the interpretation of the law by the courts or administrative tribunals. If a change occurs, the taxpayer who relies upon an outdated interpretation may be subject to additional taxes, interest and penalties, which may be imposed prospectively from the date of the change. For this reason, the interpretation set forth above should be reviewed on a regular basis. Please note that any change in or deviation from the facts presented will render this ruling inapplicable.
Should additional information be needed, please contact Senior Counsel Jan Pritchard, General Counsel's Office, Post Office Box 475, Jefferson City, Missouri 65105-0475 (phone 573-751-0961), or me.
Alana M. Barragán-Scott