The American Institute of CPAs (AICPA) has recently provided additional feedback and clarification on sourcing rules for partnership income to the Multistate Tax Commission (MTC) and its working group that is examining the state taxation of partnerships. This communication addresses various issues and questions raised by the group in response to previous correspondence from the AICPA, as well as the most recent draft of the MTC’s white paper on state tax sourcing of partnership income, pass-through tax system processes, and blended apportionment methods.
In its letter, the AICPA has recommended several adjustments to the current draft white paper, with a focus on how partnership structures, special allocations, and related-party transactions are treated within the context of state taxation. The organization has expressed concerns about the potential impact of these rules on states’ ability to tax partnership income and on the determination of how such income should be sourced.
One of the key requests made by the AICPA is for a clear definition of the guidelines that partnerships should follow when calculating entry-level taxes. Specific points raised in the letter include the revision of a footnote regarding how different states approach sourcing multistate business income based on the form of business. The AICPA also suggests adding language to address situations where states’ sourcing rules for business income differ significantly for non-resident or corporate partners.
Furthermore, the AICPA’s letter calls for additional clarification on why sourcing guidance is applied at the partner level rather than at the partnership level. It recommends incorporating the DC Circuit Court’s recent decision in Rawat v Commissioner of Internal Revenue, which pertains to determining the nature of a partner’s gain when disposing of an interest in a partnership.
Regarding related-party transactions between partners and partnerships or other related entities, the AICPA proposes that an alternative approach should only be applied if there is evidence that a transfer was intended to avoid taxation. The organization also requests additional guidance for instances where partners or shareholders act outside their official capacities.
Another recommendation put forth by the AICPA is to enhance the framework by first determining whether a taxpayer operates a trade or business before assessing if it constitutes a unitary business. The letter also suggests removing the phrase “while not clearly required for blended apportionment” in reference to the unitary business principle from the white paper.
Ning Yim, AICPA Tax Policy & Advocacy senior manager, stated, “Taxpayers and practitioners face much complexity with partnership structures, special allocations, and related-party transactions. In addition, the effect on the ability of states to tax partnership income and the determination of how partnership income is sourced is a challenge. Accordingly, we offer additional recommendations regarding the approach of the MTC white paper on these issues.”
This valuable input from the AICPA underscores the importance of ensuring clarity and consistency in the state taxation of partnership income. By addressing these critical issues, the MTC and its working group can work towards developing more effective and equitable policies for taxing partnerships.
