A Partnership’s Guide to Recording State and Local Tax Payments

When managing various payments at the state level, particularly for partnerships, it is crucial to keep meticulous records. State payments generally fall into three categories: distributions, expenses or a combination of both. Understanding how to record these payments accurately is essential for both compliance and financial clarity.

Below is a comprehensive guide for partnerships looking to more efficiently and effectively record the three most common types of state and local tax payments.

Nonresident Withholding/Composite Payments Treated as Distributions

Partnerships operating in more than one state will commonly file a nonresident withholding and/or composite return on behalf of their investors to reduce their personal filing requirements.

Understanding the Basics

• Nature of Payments: Payments made on behalf of nonresident investors are considered distributions of cash by the entity toward the investor’s state filing obligation.
• Prepaid Accounts: To avoid complications when returns are filed, it is often best practice to set up a prepaid account for payments. This helps manage discrepancies due to varying withholding rules and tax rates among different investor types.
• Periodic True-Ups: If the operating agreement requires proportionate distributions, discuss with your tax adviser whether annual or periodic true-ups are the most efficient.
• Examples of State Withholding Returns:
  • California Pass-Through Entity Annual Withholding Return Form 592-PTE
  • New York Report of Estimated Tax for Corporate Partners Form CT-2658
  • New York Report of Estimated Tax for Nonresident Individual Partners and Shareholders Form IT-2658
  • Ohio Pass-Through Entity and Trust Withholding Tax Return Form IT-1140
• Examples of State Composite Returns:
  • California Group Nonresident Tax Return Form 540NR
  • New York Group Return for Nonresident Partners Form IT-203-GR
  • Ohio Pass-Through Entity Composite Income Tax Return Form IT-4708

How to Record Entries When the Entity Directly Makes a State Payment

1. Initial Estimated Payment or Extension
   • Debit: Prepaid Tax Account
   • Credit: Cash
2. At Return Filing
   • Debit: Investor Distribution Accounts
   • Credit: Prepaid Tax Account (unless tax carryforward is requested)
   • Any differences will impact cash

How to Record Entries When a Lower-Tier Investment Makes a State Payment on the Investor’s Behalf

1. Initial Estimated Payment or Extension
   • Debit: Prepaid Tax Account
   • Credit: Lower Tier Investment
2. At Return Filing
   • Debit: Investor Distribution Accounts
   • Credit: Prepaid Tax Account (unless tax carryforward is requested)
   • Any differences will impact cash

States vary in their refund policies for these payments and may issue refunds at either the entity or investor level. Furthermore, while some jurisdictions mandate a refund, other states may allow for the application of refunds directly to future tax obligations.

Expense Payments Impacting the Entity’s Income Statement

Expenses related to state obligations, whether or not they are based on income, can affect the entity’s financial statements and tax filings.

Understanding the Basics

• Tax Conformity: States may not conform to federal treatment of state tax expenses, which could lead to modifications for state filing purposes. This can increase state-sourced income or require adjustments based on how each state’s statute is written.
• Expense Recording: Accurate recording of these expenses helps streamline the tax filing process.
• Examples of State Entity Level Expenses:
  • California Annual Minimum Fees as found on Form 565 and Form 568
  • New Hampshire Partnership Business Profits Tax Form NH-1065
  • New York Partnership, Limited Liability Company, and Limited Liability Partnership Filing Fee Payment Form IT-204-LL
  • Ohio Commercial Activity Tax (CAT) (Ohio Business Gateway)
  • Tennessee Franchise and Excise Tax Return Form FAE 170

How to Record Entries When the Entity Directly Makes a State Payment

1. Initial Estimated Payment or Extension
   • Debit: Prepaid Tax Account
   • Credit: Cash
2. At Return Filing
   • Debit: Appropriate Expense Account
   • Credit: Prepaid Tax Account (unless tax carryforward is requested)
   • Any differences will impact cash

How to Record Entries When a Lower-Tier Investment Makes a State Payment on the Investor’s Behalf

1. Initial Estimated Payment or Extension
   • Debit: Prepaid Tax Account
   • Credit: Lower Tier Investment
2. At Return Filing
   • Debit: Appropriate Expense Account
   • Credit: Prepaid Tax Account (unless tax carryforward is requested)
   • Any differences will impact cash

Pass-Through Entity Tax Payments: Handling Federal and State Implications

Pass-through entity tax (PTET) elections are complex, as they impose tax obligations on the entity to provide federal deductions for investors. Classification of these payments will impact financial statements differently based on FASB ASC 740 rules.

Understanding the Basics

• Expense vs. Distribution: PTET payments could be considered either an expense or a distribution for GAAP purposes dependent on the state mechanics of the election.
• Aligning Income, Payments and Credits: It is generally best practice to remit tax payments in the same year income is earned to properly align when the credit is received to avoid audit issues that could arise from a federal or state perspective.
• Examples of State PTET Returns:
  • California Pass-Through Entity Elective Tax Calculation Form 3804
  • New York Pass-Through Entity Tax (PTET) Annual Return (online)
  • Ohio Electing Pass-Through Entity Composite Income Tax Return Form IT-4738

How to Record Entries Based on FASB ASC 740 Treatment When Payment is a Distribution for GAAP (most common scenario)

1. Initial Estimated Payment or Extension
   • Debit: Prepaid Distribution Account
   • Credit: Cash
2. At Return Filing
   • Debit: Investor Distribution Account
   • Credit: Prepaid Distribution Account (unless tax carryforward is requested)
   • Any differences will impact cash

How to Record Entries Based on FASB ASC 740 Treatment When Payment is an Expense for GAAP

1. Initial Estimated Payment or Extension
   • Debit: Prepaid Tax Account
   • Credit: Cash
2. At Return Filing
   • Debit: Appropriate Expense Account
   • Credit: Prepaid Tax Account (unless tax carryforward is requested)
   • Any differences will impact cash

Note: Highlight PTET payments to your tax adviser for accurate reporting on federal and state returns.

Maintaining precise records for state tax payments can be intricate but is crucial for proper financial management and compliance. By using these guidelines and maintaining open communication with your tax adviser, you can help ensure accurate reporting and help avoid common pitfalls. Whether handling distributions, expenses or PTET elections, a systematic approach to recording these transactions will facilitate smoother financial operations and tax filings.

Contact Patrick Walsh or a member of your service team to discuss this topic further.

In this blog Cohen & Co is not rendering legal, accounting, investment, tax or other professional advice. Rather, the information contained in this blog is for general informational purposes only. Any decisions or actions based on the general information contained in this blog should be made or taken only after a detailed review of the specific facts, circumstances and current law with your professional advisers.