By Christian McBurney and Charles Jacobs
A recent development in the state and local tax area has been the increasing number of states that impose withholding tax on partnerships with respect to state-sourced income that is allocated to, or distributions that are made to, partners who are not residents of the state. Such states include California, New York, New Jersey and Massachusetts. Typically, these states have certificates that a tax-exempt corporation qualifying under IRC Section 501(c) can submit to the partnership to avoid withholding (even if the tax-exempt partner is allocated UBTI income). But, typically, these exemption certificates do not expressly address government pension entities and other state and local entities, which are tax-exempt under the U.S. Constitution, but not under Section 501(c). The question has arisen as to what government entities should do in this case, focusing on California and New York.
California. California Form 590, Withholding Exemption Certificate, is used by partners to certify to the partnership that the partner is a non-resident and is exempt from California withholding tax on distributions. The block for tax-exempt entities only has the following: "The above-named entity is exempt from tax under California R&TC Section 23701___ (insert letter) or Internal Revenue Code Section 501(c)___ (insert number)." Since government pension entities are exempt under the U.S. Constitution and not under Section 501(c), this form is not helpful.
There is also California Form 588, Nonresident Withholding Waiver Request, which is an application form for a California nonresident to apply to the Franchise Tax Board for a determination letter that the partner is exempt from withholding. The partner can then provide the determination letter to the partnership to avoid withholding. In the Reason for Waiver Request, there is "E. Other - Attach specific reason and include substantiation that would justify a waiver of withholding." Thus, the best course is for a government pension entity to make this application for an exemption. The instructions indicate that the FTB should issue a determination letter within twenty-one days of filing. This approach was confirmed in a recent telephone conference we had with an FTB official.
New York. New York technically does not have nonresident withholding tax. Instead, it imposes on partnerships operating in New York nonresident partner estimated tax on New York source income. By their terms, the estimated tax provisions apply only to nonresident individuals and corporations. NY Tax Law Section 658(c)(3)(A). Accordingly, if the government public pension entity is a trust or other non-corporate entity, this estimated tax provision does not apply.
If the government entity is a corporation, which is infrequent, New York State Form CT-2658-E provides that the exemption only applies if the corporation "is exempt from any taxes imposed by the New York State Tax Law, Articles 9, 9-A, 32 and 33." It may be that a government entity that is organized as a corporation qualifies under this standard, since New York State starts its taxable income calculations with federal taxable income, and government entities organized as corporations may be excluded from having federal income under either the U.S. Constitution or IRC Section 115(1).
If you have any questions, please contact:
Christian McBurney at (202) 585-8358 or firstname.lastname@example.org or
Charles Jacobs at (212)940-3170 or email@example.com.