Response
March 22, 1993
Request
March
1, 1990
XXXXX
Dear
XXXXX:
I
appreciated very much your meeting with me to discuss the composite filing to
be completed for XXXXX for the XXXXX calendar year. As you recall, our
discussion centered on the recently issued Regulation R865-9-131. This Regulation deals with the treatment of
nonresident partners included in composite returns. The Regulation takes the position that no deduction shall be
allowed to a composite filer and additionally requires tax to be paid at the
maximum rate. This is a departure from
the past filings which have been made by our Firm which have been approved by
the Tax Commission. We as a Firm have
been forthright in discussing with the Tax Commission positions that have been
taken in previous filings. Accordingly, a question arises as to the effective
date of the Regulation and how this Regulation should apply to our Firm given
our past agreements with the Tax Commission.
I
believe that it is inequitable to deny deductions to a composite filer that
would be afforded to any nonresident who files a return in Utah. This position seems out of line with what is
afforded under the Utah Law.
Accordingly, I would propose the XXXXX composite return be allowed a
federal income tax deduction equal to 14 percent of Utah income. Fourteen percent is derived by taking 50
percent of the 28 percent federal rate.
It is recognized that the maximum federal rate is 33 percent. As such, a 14 percent deduction rate
represents an amount that should be less than the amount actually being paid by
our partners. This position could be
supported if the Tax Commission would clarify the effective date of the
Regulation to be prospective for composite filers who have disclosed in the
past their filing methodology for the federal tax deduction and received State
approval. This is the circumstance for
our Firm.
Additionally,
we hereby request that guaranteed “payments salary and interest” and certain
payments made pursuant to IRC §736(a)(2) be sourced to the state of residency
and excluded from the income subject to the apportionment formula. We make this request pursuant to Utah Code
Annotated 59-10-303(4) which gives the Tax Commission authority to make
equitable adjustments as may be appropriate.
The
foregoing request results in a more equitable allocation to the State of Utah for
the following reasons. The XXXXX partnership agreement provides that each
partner will receive a $$$$$ guaranteed payment as part of his
compensation. Such services are
rendered by partners in various states throughout the country and this $$$$$
amount represents a minimal amount of compensation for service rendered in the
State of residence. It would seem
appropriate to source this income to the state of residency rather than
requiring it to be included in apportionable income.
Payments
made pursuant to Internal Revenue Code Section (IRC §) 736(a)(2) which are also
guaranteed payments are made primarily to retired partners and similarly should
be sourced to their state of residency.
These payments are fixed and determinable payments calculated without
reference to partnership income. Such
payments are made pursuant to deferred compensation formulas the partnership
utilizes. These items are in the nature
of an expense to active partners.
The
partnership also pays partners interest on their respective capital and drawing
account balances. This interest, by
equity, should be sourced to the partners' state of residency rather than being
includible in apportionable income.
Utah and other states tax interest and also dividend income received by
individuals to their state of residency (Utah Code Annotated
59-10-118(6)). As such, it would be
appropriate to exclude such amounts from income subject to apportionment for
Utah purposes.
Should
you require further detailed information regarding the guaranteed payments, I
would be happy to provide this information to you.
I
would appreciate your consideration of these matters at the earliest possible
time as they are of some urgency for our Firm.
I thank you in advance for your consideration.
Very
truly yours,
XXXXX
cc:
XXXXX
Your
letter of XXXXX has been reviewed and discussed with the Auditing
Division. Utah Code Annotated 59-10-301
states, “ . . . Persons carrying on business as partners are liable for the tax
imposed by this chapter only in their separate or individual capacities.” As the Tax Commission interpreted the law, a
composite return for a partnership was not allowed. However, for the convenience of the taxpayers, agreements were
made with certain partnerships in the past to allow composite returns to be
filed. These agreements varied from
partnership to partnership. The intent behind Rule R865-9-13I was to formally
allow partnerships with hundreds or thousands of non-resident partners with
negligible amounts of income attributable to Utah to file a composite Utah
return on behalf of those partners and to standardize what would be allowed in
a composite return. It was never our
intention that composite returns would take the place of all non-resident
partners' individual returns, regardless of the amount of their income or
complexity of their situation.
Utah
Code Annotated 59-10-303 (2) indicates that “In determining the sources of a
nonresident partner's income, no effect shall be given to a provision in the
partnership agreement which: (a) characterizes payments to the partner as being
for services or for the use of capital . . .” As you discuss in your letter,
the $$$$$ guaranteed payment is for services rendered by partners and those
payments need to be allocated to Utah.
Section
736(a)(4) of the IRC indicates that payments, to the extent considered as
guaranteed payments under 736(a)(2), are taxable as ordinary income to the
recipient and therefore should be allocated to Utah.
The
Auditing Division has proposed a change to Rule R865-9-13I which would allow a
deduction equal to 15 percent of the Utah taxable income attributable to
non-resident partners included in the composite filing. The deduction would be allowed in place of a
standard deduction, itemized deductions, personal exemptions, federal tax
determined for the same period, or any other deductions. The proposed effective date for this rule
change would be for tax years beginning during XXXXX. These rule changes have
not yet been issued for public comment.
The
original changes to Rule R865-9-13I were effective for tax years beginning in
XXXXX. If the non-resident partners of
your firm wish to have all applicable deductions, they can file an individual
non-resident return for XXXXX.
Sincerely,
XXXXX
The
XXXXX statute is located in the Tax Commission files.
The
XXXXX Form is located in the Tax Commission files.
Utah
State Tax Commission
Heber
M. Wells Building
160
East Third South
Salt
Lake City, Utah 84134-0300
Dear
Chairman Hansen:
We
are writing to request an advisory opinion on behalf of XXXXX as to the
treatment of certain guaranteed payments.
XXXXX
presently files a composite return for nonresident partners pursuant to Utah
State Regulation R865-9-13I. In filings
prior to XXXXX, guaranteed payments for services or for the use of capital have
not been deducted in determining “adjusted income” of nonresident partners
under the regulation. We are writing to request an advisory opinion that XXXXX
be allowed a deduction for certain services and for interest for the use of
capital which we believe to be consistent with Utah provisions as explained
below.
The
intent of Utah Tax Code (UTC) Section 59-10-303(2) is to treat a guaranteed
payment in the context of what it actually is, rather than permit the
partnership agreement to determine the characterization of the payment. To the
extent that such payments represent in substance and without regard to the
partnership agreement, compensation and interest on capital accounts, the
source of such payments would follow the situs of the service and domicile of
the nonresident partner respectively. Specifically, UTC 59-10-303(2) provides
in pertinent part, “In determining the sources of a nonresident partner's
income, no effect shall be given to a provision in the partnership agreement
which: (a) characterizes payments to the partner as being for services or for
use of capital. . .” . This language does not deny a partnership a deduction
for such payments, nor does it deny a nonresident partner the right to treat
such payments based on their merit for purposes of applying the sourcing
methodology required of nonresidents generally.
The
relevant language in the XXXXX partnership agreement reads as follows: “Notwithstanding the profits (or losses) of
the Firm, each partner shall receive a salary at the annual rate of $$$$$
($$$$$)....” Under UTC 59-10-303(2) no effect is given to the term “salary”, a
term which characterizes the payment made to the partner. Instead, the XXXXX
provision is interpreted as requiring the payment (a noncharacterization word)
to each partner without regard to the partnerships' profits or losses.
Under
IRC §707(c), payments made to partners “without regard to the income of the
partnership” are considered as made to nonpartners, provided such payments are
for services or the use of capital. This Section 707 provided treatment is
specifically incorporated into the Utah law by UTC 59-10-302(1). Accordingly, even though UTC 59-10-303(2)
ignores the characterization of these payments by the partnership agreement as
salary, IRC §707 and UTC 59-10-302(1) provide for such treatment to the extent
the payments are in substance salary.
Therefore,
we would conclude these payments are deductible by the partnership. Since UTC
59-10-303(2) does not deny the partnership a deduction for true guaranteed
payments, it is not inconsistent with the utilization of federal taxable income
as characterized in UTC 59-10-302(1) as the partnership's apportionment base
pursuant to Reg. R865-9-13I.
Accordingly, we respectfully request XXXXX be allowed a deduction for
salary and interest on capital accounts in determining the Utah apportionable
base for purposes of filing its composite return. We propose that this change be prospective for calendar years
subsequent to XXXXX.
In
further support of our request, we would like to point out that despite
statutory language identical to that of Utah's, the State of Maine, in its
forms, (a copy attached) uses ordinary income as its apportionment base after
deduction of guaranteed payments as shown on Federal Form 1065. (A copy of the
Maine statute is attached for your reference). As computed on the Federal Form,
this would be after deductions for salary and interest on partner capital
accounts.
I
submit the following comments in summary.
UTC 59-10-303(2) operates only to ignore partnership agreement language
which characterizes payments as compensation for services. It does not deny the right to treat the
payment as such if the substance of the payment reflects a guaranteed payment
for services. UTC 59-10-302(1), IRC
§707 and Treas. Reg. 1.707-1(c) all require that XXXXX deduct all payments
which are in substance payments for services.
The deduction for compensation for services and interest on capital
accounts in arriving at partnership apportionable income (adjusted income
pursuant to R865-9-13I) is consistent with all Federal/Utah statutes and regulations
as cited above. Your prompt consideration of this matter will be very much
appreciated.
Very
truly yours,
XXXXX
TO:
XXXXX, Director
FROM:
XXXXX, Secretary
DATE:
XXXXX
SUBJECT: Request for Advisory Opinion - No. 93-006DJ
Attached
is a request for an advisory opinion from XXXXX of XXXXX. Will you please
review the request of XXXXX concerning the treatment of certain guaranteed
payments.
Please
prepare the response for signature by the Commission as per the guidelines established
by them.
Thank
you.
cc:
Joe Pacheco
XXXXX
XXXXX
RE:
Treatment of Certain Guaranteed Payments
Your
request for an advisory opinion regarding XXXXX allowance for salary
(guaranteed payments) and interest on capital accounts in determining the Utah
apportionable base for purposes of filing its nonresident composite partnership
return was referred to the Auditing Division for their analysis.
It
is the division staff recommendation that:
IRC
Section 707 provides that any fixed or guaranteed amounts paid by a partnership
to its partners for services or for the use of capital (loans made to the
partnership by the partner), without regard to the income of the partnership,
are treated as though they were paid to an outsider for only two purposes.
These “guaranteed payments” are taxed as salary or interest to the partners and
allowed as ordinary and necessary business deductions to the partnership.
However, the partner must report the salary or interest as though it were a
part of his distributive share of the partnership income.
For
purposes other than determining the ordinary income (loss) of the partnership,
guaranteed payments are regarded as a partner's distributive share of ordinary
income.
Utah
Code 59-10-303 indicates that in determining the sources of a nonresident
partner's income, no effect shall be given to a provision in the partnership
agreement which characterizes payments to the partner as being for services or
for the use of capital or allocates to the partner, as income or gain from
sources outside this state, a greater proportion of his distributive share of
partnership income or gain than the ratio of partnership income or gain from
all sources.
Although
XXXXX indicates guaranteed amounts paid by the partnership to its partners for
services or interest for the use of capital are made without regard to the
income (loss) of the partnership, it does not change the fact that such
payments would be made from gross income of the partnership that was derived
from carrying on the business of the partnership in the different states.
Therefore,
guaranteed payments from the partnership should be allocated to Utah.
Based
upon the facts presented in your letter, we are in agreement with the Auditing
Division's recommendations. Obviously, if there are deviations from these
facts, this opinion may be negated.
If
you do not agree with this determination, you may appeal to the Tax Commission
for a formal hearing. The results of that hearing would constitute a
declaratory judgment and be appealable to the Utah State Supreme Court. A
Notice of Appeal Rights and copy of the Utah Taxpayer Bill of Rights are
attached.
For
the Commission,
Joe
B. Pacheco
Commissioner