When you become or are a partner, it is quite common that you now need to file returns in more than one state. This is true for anyone that is a partner in a partnership, or member in a LLC, that operates in multiple states. This article provides an overview of why and key points for filing in multiple states.
Why You File in Multiple States
The reason partners have to file in multiple states is because the partnership is a pass-through entity. This is also true for members in LLCs or S Corporations. Income of a pass-through entity is “passed through” to its owners. That means, as a general rule, the partnership or entity does not pay taxes on its income at the entity level. Instead, the income is passed to its owners who then pay taxes on the entity’s income.
Consequently, if the partnership has income generated in a state, that income is passed to the partner such that the partner now has income generated in that state. This contrasts with W-2 income, which is generated by where the person works. So when you become a partner, your physical location no longer governs where your income is generated. Instead, it is governed by where your partnership does business.
Key Points for Filing in Multiple States
There are two key points to keep in mind when having income from multiple states as a partner or member: tax credits for taxes paid in another state and tax credits for income taxes paid by the partnership.
Your state of residence, as a baseline, taxes all of your income regardless of where it is generated. To avoid double taxation, most states will give you a tax credit for taxes paid to another state. It is an easy step to miss but it is critical savings, requiring a few more forms, amounting to a dollar-for-dollar offset of your resident-state tax obligation.
Second, your partnership may have elected to pay taxes at the entity level. It does this as a way to help you avoid the $10,000 cap on state income taxes at the federal level. I discuss this more in an earlier blog (link). If it has done this, then you will either receive a tax credit from the state in which the partnership paid taxes or you will adjust your income reported in that state to remove income on which income taxes were already paid. States do not have a consistent way to do this, so it takes some research to do correctly.
Overlooking these benefits can result in skipping over tax savings at the state level. If you need assistance taking advantage of them, please reach out! Mid-Atlantic Law & Tax PLLC has a depth of experience on helping clients take advantage of these elements of their return. We would be happy to help you navigate them.
