Louisiana Revised Statutes Section 47:201.1 and the Taxation of Nonresident Partners: An Alternate Proposal

• Author: Susan Kalinka
• Position: Harriet S. Daggett-Frances Leggio Landry Professor of Law

Harriet S. Daggett-Frances Leggio Landry Professor of Law, Louisiana State University, Paul

During its 2000 session, the Louisiana Legislature added Section 47:201.1 to the Louisiana Revised Statutes.¹ Section 47:201.1 is designed to ensure that a nonresident owning an interest in a partnership or LLC that transacts business in Louisiana will pay Louisiana income tax on the nonresident's distributive share of the entity's Louisiana income. The requirements of Section 47:201.1 apply to partnerships in commendam, registered limited liability partnerships, and LLCs that are classified as partnerships.² For convenience, this article will refer to all such entities as "partnerships," and all owners of interests in such entities as "partners."

Section 47:201.1 closes an important loophole. The Louisiana income tax law always has required nonresident partners to pay tax on their shares of Louisiana income earned by a partnership. However, before Section 47:201.1 was enacted, there was no way to ensure that nonresident partners actually would pay the tax.

This article discusses the new law and the steps that must be taken to comply with its requirements. The new law offers taxpayers a choice that should be considered carefully. While Section 47:201.1 is designed to ensure payment of Louisiana income tax by nonresident partners, it does not ensure collection of tax from owners of interests in single-member LLCs or other entities that are disregarded as separate entities from their owners for tax purposes ("disregarded entities"). Section 47:201.1 also creates some ambiguity as to whether it applies to corporate partners. It is likely that the Louisiana Legislature will reconsider the statute and its application to corporate partners and owners of interests in disregarded entities. However, if the law is to be amended, the Louisiana Legislature should consider another method for collecting Louisiana income tax from nonresident partners and members of disregarded entities. This article suggests a more effective method of taxing partnerships and disregarded entities. The proposal advocated by this article would make applicable to a partnership or disregarded entity rules similar to the rules that apply to S corporations under the Louisiana Corporation Income Tax Act. M. Hebert Law Center. Parts of this article were derived from Susan Kalinka, Louisiana's Taxation of S Corporations offers Advantages Not Available in Other Jurisdictions, 78 Taxes 26 (Nov. 2000).

Partnerships and S corporations are pass-through entities for federal tax purposes. In general, a partnership or S corporation does not pay federal tax on its income.³ Instead, each partner pays tax on its distributive share of partnership income and each shareholder pays tax on a pro rata share of the S corporation's income.⁴ Similarly, disregarded entities, such as single-member LLCs⁵ and qualified subchapter S subsidiaries⁶ do not pay tax on their income. Instead, the owners of such entities pay the tax.

Most states follow the federal rules in treating partnerships, S corporations, and disregarded entities as pass-through entities.⁷ Only a few states tax a partnership or an S corporation as a separate entity.⁸

If a state taxes a partnership or S corporation as a pass-through entity, there may be constraints on the state's ability to collect the tax directly from nonresident partners, S corporation shareholders, or owners of disregarded entities. There is some concern that a state may not have jurisdiction to seek the tax directly from a nonresident partner, S corporation shareholder, or disregarded entity owner. While the jurisdictional limitation is probably more of a concern than necessary, there are practical limitations that prevent a state from seeking the tax from a nonresident that does not have any assets in the state.

Section 47:201.1 of the Revised Statutes avoids these limitations by adopting the method used in many other states for collecting tax from nonresident partners and S corporation shareholders. Under Section 47:201.1, the partnership must withhold and pay to the state the tax on a nonresident's share of the partnership's income unless the nonresident partner agrees to be responsible for payment of the tax. Like the withholding statutes of other states, Section 201.1 permits, but does not require, the partnership to file a composite return, reporting and paying tax on a nonresident's share of the entity's income.⁹

The withholding requirement can be problematic, especially for S corporation shareholders. The payment of a nonresident shareholder's state income tax by an S corporation is treated as a constructive distribution to the nonresident shareholder.¹⁰ If the S corporation neglects to distribute a pro rata amount of cash or property to its resident shareholders in a year in which it pays tax on behalf of nonresident shareholders, the corporation will be considered to have more than one class of stock.¹¹ In that case, the corporation's subchapter S election will terminate.¹²

While the withholding requirement is not as troublesome for partnerships as for S corporations, it poses potential problems in the partnership context. If a partnership pays state income tax on behalf of its nonresident partners, but not on behalf of its resident partners, accounting entries must be made each year to adjust the partners' capital accounts, or else offsetting distributions must be made to the resident partners to compensate them for the benefit the partnership conferred on the nonresident partners unless the nonresident partners reimburse the partnership. A partnership's payment of the tax may divert partnership funds that would better be used to invest in partnership operations.

In lieu of filing composite returns and paying Louisiana income tax on behalf of a nonresident partner, Section 47:201.1 permits the partnership to file an agreement by the nonresident partner in which the nonresident partner agrees to file Louisiana income tax returns and pay tax on the nonresident's share of partnership income. In this respect, the Louisiana statute is similar to statutes in other states that require nonresident S corporation shareholders to submit to the state's taxing jurisdiction.¹³ Unlike the Louisiana alternative, however, these S corporation statutes require the nonresident shareholders to agree to be subject to the state's taxing jurisdiction as a condition of permitting the S corporation to be treated as a pass-through entity. If an S corporation transacts business in such states, the shareholders must monitor all stock dispositions. If a nonresident acquires stock in the corporation, steps must be taken to ensure that the new shareholder signs an agreement submitting to the state's taxing jurisdiction. Otherwise, the S corporation may lose its status as a pass-through entity for state income tax purposes.

Louisiana has a different method of taxing an S corporation. The Louisiana income tax law allows an S corporation to be treated as a pass-through entity only to the extent that the shareholders actually pay tax on their pro rata shares of the corporation's Louisiana income. Nonresident shareholders are not required to agree to be subject to the state's taxing jurisdiction in order to ensure pass-through taxation, at least with respect to income allocable to resident shareholders. If a nonresident shareholder does not pay the tax on the nonresident's share of the corporation's Louisiana income, the corporation must pay the tax.

As explained above, the withholding and payment of state tax by an S corporation is treated as a constructive distribution to a nonresident shareholder. In contrast, the Louisiana Corporation Income Tax Act treats the tax as an obligation of the corporation. The Louisiana income tax law also eases the administrative burden of collecting tax from nonresident shareholders of an S corporation.

A partnership is a pass-through entity for Louisiana income tax purposes.¹⁴Until the Louisiana Legislature enacted Section 47:201.1 of the Revised Statutes, however, the state had not adopted a withholding requirement or any other method to ensure that a nonresident partner would pay tax on the partner's distributive share of the partnership's Louisiana income. While Section 47:201.1 resolves a number of concerns about the state's ability to tax a nonresident partner, the statute could be improved by adopting a method of taxing partnerships and disregarded entities that is similar to the rules that Louisiana uses for taxing the income of an S corporation transacting business in Louisiana.

The Louisiana rules for taxing S corporations provide administrative convenience and may protect the corporation from an inadvertent termination of its subchapter S election. However, S corporation shareholders must plan ahead to avoid other problems that may arise as a result of the Louisiana tax law. This article provides planning suggestions for shareholders in an S corporation transacting business in Louisiana. If Louisiana adopts the proposal for taxing nonresident partners advanced by this article, the same planning suggestions should be considered for taxpayers using the partnership form to conduct a Louisiana business.

I The Need For Section 47:201.1: Jurisdiction To Tax

The ability of a state to impose a tax on the income of a nonresident is limited by the United States Constitution. In order for a state to impose a tax on a person's income, the person or the income must have a sufficient "nexus" with the state.¹⁵ A state may impose a tax on the income of an individual who is a resident of the state, no matter where the...