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New Massachusetts Rule May Require Pass-Through Entities to Withhold Taxes


									DLA Piper | Publications | Property Owners in Massachusetts Note: New Massachusetts ...

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6 APR 2009

Property Owners in Massachusetts Note: New Massachusetts Rule May Require Pass-Through Entities to Withhold Taxes

Barbara A. Trachtenberg Joseph A. Hugg

Under a new program adopted by the Massachusetts Department of Revenue, pass-through entities that have offices in Massachusetts or that are doing business in Massachusetts may be required to withhold taxes from the Massachusetts income allocated to their owners. The new regulations, 830 CMR 62B.2. (the Regulations), which apply to tax years beginning on or after January 1, 2009, will require withholding unless the pass-through entity, or the owner entitled to the income, is exempt. Given that most real estate investments are made through pass-through entities, the new Regulations will have widespread effect for owners of property in the Commonwealth of Massachusetts. The Regulations require pass-through entities to determine if they are exempt from Massachusetts withholding, and if not, whether their owners are exempt from Massachusetts withholding. If neither the pass-through entity nor the owners are exempt, then the entity will have to withhold taxes from income allocable to the non-exempt owners and remit those taxes to the Commissioner of the Department of Revenue (the Commissioner). To comply with the new Regulations, the pass-through entity will need to: 1. 2. 3. 4. register for withholding by filing a Schedule PTE with the Commissioner; obtain a certificate from the exempt owners and keep it on file, as described below; and withhold taxes on the allocable income attributable to non-exempt owners and remit the withholdings to the Massachusetts DOR, as described below. File an annual withholding return and note the filing of Schedule PTE on the return. 4/7/2009

DLA Piper | Publications | Property Owners in Massachusetts Note: New Massachusetts ...

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In order to avoid the withholding, an exempt owner must deliver the exemption certificate to the passthrough entity no later than April 30, 2009 for the current tax year. The following includes more detail on what a pass-through entity is, which pass-through entities are exempt and how owners of pass-through entities are exempt, as well as the registration and withholding requirements for non-exempt pass-through entities. What is a “Pass-Through Entity” for Purposes of Massachusetts Withholding? A pass-through entity is any entity whose income, loss deductions and credits flow through to its owners for Massachusetts tax purposes. This is likely to include any general partnerships, limited partnerships, limited liability partnerships, limited liability companies, S corporations, and trusts and estates that are not taxed at the entity level. What Pass-Through Entities are Exempt from the Massachusetts Withholding? Pass-through entities that are exempt from withholding are (1) “investment partnerships,” as defined in the Regulations; (2) trusts required to withhold under another Massachusetts provision; (3) in a multitiered ownership structure, an upper-tier pass through entity that can demonstrate that the lower-tier entity has previously withheld and made estimated tax payments that would have been subject to withholding by the upper-tier entity; and (4) publicly traded partnerships (but such publicly traded partnerships are required to comply with reporting requirements). An investment partnership is defined as an entity treated as a partnership under tax law, which meets all of the following criteria (a) substantially all of the assets of the investment partnership consist of investment securities, deposits at banks or other financial institutions or office equipment and office space reasonably necessary to carry on the activities of the investment partnership; (b) substantially all of the partnership’s income is from interest, dividends and capital gains; and (c) the partnership is not engaged in a trade or business in Massachusetts. Which Owners of Interests in Pass-Through Entities are Exempt from Massachusetts Withholding? The following owners of pass-through entities are exempt from withholding under the Regulations: 1. 2. Individuals, estates or trusts that certify that they are Massachusetts residents. With respect to owners that are exempt from federal income tax under IRC §501, withholding is not required on distributions to those members/partners to the extent that such income is exempt from Massachusetts tax under M.G.L. chapters 62 or 63. Corporations that have income, other than pass-through income, subject to tax under M.G.L. ch. 63 and that are filing a return and that certify to the filing of a Massachusetts return or presence in Massachusetts. Pass-through entities that have a usual place of business in Massachusetts and that certify to their filing of a Massachusetts tax return or a presence in Massachusetts. Non-resident members/partners who establish that they are compliant with Massachusetts tax laws by either (a) participating in a composite tax return prepared by the pass-through entity; or (b) filing a certification with the pass-through entity, stating that they agree to file tax returns, make quarterly estimated payments and accept personal jurisdiction in Massachusetts state courts for the determination and collection of taxes. Upper-tier pass-through entities who certify that all of their owners qualify under one of the


4. 5.

6. 4/7/2009

DLA Piper | Publications | Property Owners in Massachusetts Note: New Massachusetts ...

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exemptions listed above. If an owner claims exemption, the pass-through entity may nonetheless be required to withhold taxes from distributions to such owner if the Massachusetts DOR notifies the pass-through entity that the owner has failed to timely file and pay taxes in Massachusetts. What Must Exempt Owners Do to Claim Their Exemption? For an owner to be treated as exempt by the pass-through entity, the owner must file a Massachusetts DOR Form PTE-EX with the pass-through entity, on or before the later of (a) the last day of the fourth month of the pass-through entity’s taxable year (April 30 for most pass-through entities), or (b) within 30 days of the member/partner joining the entity. You may obtain a copy of the form here. If the Pass-Through Entity’s Owners are not Exempt, What Must the Pass-Through Entity Do? The pass-through entity must register with the Massachusetts Department of Revenue (DOR), withhold taxes from distributions to its non-exempt members, make quarterly payments to the DOR (due on the last day of the month following the end of each tax quarter) of the amounts withheld and file an annual withholding return with the Commissioner. In addition, the entity must notify each of its non-exempt members of the amount withheld on a Schedule 3K-1 or SK-1, as appropriate. The Regulations provide a safe harbor for the amount to be withheld.1 Although the amount withheld can be applied against the amount of any estimated tax payments required to be made by an owner, the withholding does not replace the obligation to make such estimated payments. How are Multi-Tiered Structures Affected by the New Regulations? When an ownership structure involves pass-through entities at multiple levels, then the withholding obligation begins with the lowest-tiered entity (i.e., the one that is closest to the Massachusetts-source income). That entity must either withhold or obtain exemption certifications from its upper-tier passthrough owners, and the upper-tier entities must either withhold or obtain exemption certifications from their owners. If a lower-tier pass-through entity has withheld taxes on income allocated to the upper-tier entity, then it is up to the upper-tier pass-through entity to allocate those withheld amounts among its owners.

1 The safe harbor for each non-exempt member is an annual amount equal to the product of (i) the withholding rate and (ii) the lesser of (a) 80% of the member’s distributable chare for such tax year or (b) 100% of the member’s distributable share for the prior tax year. The withholding rate is depends on the non-exempt member’s tax status. 4/7/2009

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