When it comes to filing tax returns, doing business in multiple states can cause headaches for a pass-through business and its owners. Not only does the business have to file taxes in the states it does business in, but each owner needs to file individually in those states as well. This will always be the case, unless the entity (along with its owners) consents to filing composite tax returns for each of the non-resident individual owners in each state.
The major advantage to filing composite tax returns is that only the business needs to file tax returns in the states it actually does business in. Tax is paid at the entity level on behalf of the owners; the individuals need not worry about including these states with their individual tax filings.
One situation to consider is one or some of the owners may have other business activities in these states, unrelated to the pass-through entity. If so, it is best for the owner to discuss the advantages, disadvantages, and availability of filing composite tax returns with their tax advisor.
However, not all states allow composite tax returns. Some states actually require a minimum number of non-resident owners to participate. Also, some states with graduated rates tax non-resident individuals on composite tax returns at the highest tax rate, whereas they might be at a lower rate filing individual tax returns in those states.
Filing composite state tax returns can be a great benefit and alleviate a lot of stress when it comes time to file individual returns for non-resident shareholders or partners. But, as described above, it is not for everyone. If you have a business that operates in multiple states, please feel free to contact us so we can advise you on a tax strategy that is most advantageous for your business and its owners.
Written by Erik Blaushield, CPA