The states of Massachusetts and Illinois recently enacted withholding requirements for flow-through entities. These states joined a score of states that enacted similar measures to prevent nonresident partners, members and shareholders from avoiding their personal filing requirements.

The current list of states with similar withholding requirements include: California, Colorado, Georgia, Indiana, Kansas, Kentucky, Michigan, Minnesota, Missouri, Nebraska, New Jersey, New Mexico, New York, North Carolina, North Dakota, Oklahoma, Oregon, Pennsylvania, South Carolina, Virginia, and Wisconsin.

Other states often opt to levy the tax directly upon the pass-through entity. If the burden is shifted to the entity, then the entity’s return generally adds several lines whereby nonresidents’ income shares are gathered and a tax, payable by the entity, is calculated. Whether choosing a shifted tax burden or a withholding method, states generally exempt portions to nonresidents if the income to the nonresident would otherwise not be taxable.

The new Massachusetts withholding provision can be found at 830 CMR 62 B.2.2, and Illinois provides guidance for its new legislation via its November 2008 issued “Pass-through Entity Payments Q&A”. The state variations certainly can lead to confusion. Given the states’ continued tweaking of their laws for this area, withholding requirements should always be investigated when a pass-through has a nonresident distributee.