Walter & Shuffain, P.C.

Pass Through Entities Required to Withhold Tax In Massachusetts

For tax years beginning on or after January 1, 2009, pass through entities must withhold personal income tax or corporate excise tax as to all members unless either the pass through entity or the member is exempt.

Who Must Withold

A pass through entity that maintains an office or engages in business in Massachusetts must deduct and withhold Massachusetts tax from the member's pro rata share of the pass through entity's Massachusetts source income.

Entities that are exempt from the pass through withholding requirement are:

An investment partnership
A trust required to withhold under another Massachusetts provision; and
An upper tier pass through entity in a tiered structure that can demonstrate that a lower tier pass through entity has previously withheld and made estimated payments of all of the Massachusetts tax on Massachusetts source income that would be subject to withholding by the upper tier entity.

An investment partnership includes a limited liability company that meets the following 3 criteria:

Substantially all of the partnership's assets consist of investment securities, bank deposits, or office equipment and space reasonably necessary to carry on the activities of an investment partnership
Substantially all of the partnership's income is from interest, dividends, and capital gains; and
The partnership is not engaged in a trade or business in Massachusetts.

Exempt members will generally fall into one of the categories below. For an exempt member, the pass through entity must obtain a certification that the member is exempt on a form approved by the Commissioner on or before the end of the first month of the tax year (or within 30 days of the member joining the entity). This certification must be retained and produced on request.

Federally Tax Exempt. With respect to members that are exempt from federal income tax under IRC 501, withholding is not required as to nonresident members distributive shares to the extent that such income is exempt from Massachusetts tax as certified to the pass through entity by the member.
Individuals, trusts or estates who certify that they are Massachusetts residents.
Corporations that are subject to tax in Massachusetts (other than on their pass through income) or pass through entities that have a usual place of business in Massachusetts. These entities must certify to their filing a Massachusetts return or presence in Massachusetts.
Participating nonresidents, who either participate in the filing of a composite return or file a certificate stating that they agree to file tax returns, make estimated tax payments, and accept personal jurisdiction in Massachusetts state courts for the determination and collection of taxes.
Upper tier pass through entities whose members are exempt and who certify to that effect.

Income Subject to Withholding; Quarterly Payment

The amount of tax to be withheld is calculated quarterly based on Massachusetts taxable amounts of income allocated to a member subject to withholding. The required annual payment on behalf of each member subject to withholding is calculated by multiplying the withholding rate by the lesser of 80% of the member's current year income or 100% of the member's prior year income. The withholding tax is due quarterly on or before the last day of the month following the close of the quarter. The withholding rates generally are 5.3% for individuals, estates or trusts, and 9.5% for corporations. There are rules in place to avoid multiple withholding on the same income in the case of a tiered structure.

Credit for Tax Paid; Members' Estimated Payment Obligation

Amounts withheld shall be considered to be the payment of the tax imposed on the member for distributive share income derived by the member from the pass through entity and shall be credited against the member's tax liability for the member's tax year. Notwithstanding this withholding obligation, members are responsible for the payment of estimated tax on all of their income. If withholding is insufficient to satisfy a member's estimated tax obligation, interest and penalties may be imposed.

Examples

The regulation provides 3 examples to illustrate the application of these rules.

Example 1

Pass-Through Entity and Member both use the calendar year as their taxable year. Member is a corporation. Pass-Through Entity allocates Member's distributive share of $100,000 of taxable Massachusetts-source income to Member in year 1 and the same amount in year 2. For year 2, Member seeks to be within the estimated payment safe harbor by paying 100% of its prior year corporate excise. To avoid interest and penalties, Member must make an estimated payment in an amount totaling 40% x year 1 corporate excise on or before March 15. Pass-Through Entity, relying on its safe harbor of paying 100% of Member's prior year corporate excise, must withhold and pay, on behalf of Member, an amount totaling 25% x corporate excise tax rate x $100,000 on or before April 30th. Member may reduce its June 15 estimated tax payment by the amount paid by Pass-Through Entity on April 30.

Example 2

Pass-Through Entity and Member both use the calendar year as their taxable year. Member is an individual. Pass-Through Entity makes its first installment payment on behalf of Member for the taxable year on April 30. Member's first estimated payment is due April 15th. Member must make her first estimated payment on April 15, and may take a credit on her June 15th estimated payment for the amount paid by Pass-Through Entity on her behalf on April 30th.

Example 3

Same facts as Example 2, except that Pass-Through Entity makes its first installment payment on behalf of Member for the taxable year on April 15th. Member's estimated payment obligation with regard to her income from Pass-Through Entity has been met.

Reporting Requirements

Pass through entities with nonresident members must submit, by the end of the 3rd month following the taxable year, an annual schedule for pass through entities, which will be part of its annual return. The schedule will include all members who are not exempt with the exception of members who are exempt because they are participating in a composite return or have agreed to file and subject themselves to Massachusetts jurisdiction. Special rules apply for tiered structures.

The annual schedule shall show for each member required to be included, the following information:

Name
Type of taxpayer (e.g., individual, corporation, or pass through entity
Tax identification number
Address
Method of tax compliance (e.g., participation in composite return, agreement to file, or withholding
Massachusetts source distributive share
Amount withheld on behalf of the member, and
Any other information the Commissioner requires.

If withholding is required for any member, the pass through entity must:

Register for Massachusetts withholding on amounts paid, credited or allocated to a member
Report and remit the withheld tax before the last day of the month following the close of the quarter
File an annual withholding return by the end of the 3rd month following the taxable year showing the amount withheld and any other required information, and
Furnish to each member a statement of the amount withheld and paid during the taxable year on the member's behalf. If the pass through entity is a partnership, the information should be on the partner's Massachusetts information schedule. Other types of entities should use a form approved by the Commissioner.