1. Partnerships, LLCs and LLPs:
State Tax Issues
Presented by
Mike Galloway
Member
Bancroft Susa & Galloway, PC
www.arizonatax.com
Bancroft Susa & Galloway
A PROFESSIONAL CORPORATION
3. Ha Ha!
A. What is the difference between
Osama Bin Laden and a
lawyer?
A. Bin Laden has some good
qualities.
4. Top 10 Reasons Why Lawyers
Should Replace Lab Rats
1. There is an endless supply.
2. Lab assistants don’t get attached to them.
3. It’s more fun to shave and stick needles in lawyers.
4. There are some things rats just won’t do.
5. It’s fun to dispose of them when you’re through.
6. It’s not “inhumane” treatment, when it comes to
lawyers
7. No one cares when a lawyer squeals.
8. We’ve seen what happens when they are allowed
to breed in the wild.
9. Lawyers belong in cages.
10. Animal rights activists don’t care if you torture
lawyers.
5.
6. In General
• An LLC will be classified for Arizona
income tax purposes as either
– A partnership
– A corporation (including an S), or
– A disregarded entity
depending on its classification for federal
income tax purposes under Treas. Reg.
§§ 301.7701-1 etc.
7. Choosing The Right Tax
• If the LLC is classified as a partnership,
it will report its income to Arizona on
Form 165
• If classified as a corporation, on Form
120
• If classified as a S Corporation, on Form
120S
• If a single member LLC is disregarded
as an entity separate from its owner, on
the Arizona tax return of its owner
8. The Partnership Rules
• The old law — Arizona had its own
independent partnership tax code
• Now — Arizona taxable income "piggy
backs" from federal income — the
federal "flows through" to the state
– Federal taxable income equals
Arizona gross income
– Look at the tax return
9. The Partnership Rules
• Add or subtract the separate computation items
of A.R.S. § 43-1412
• Make the individual statutory additions and
subtractions
• Allocate this amount to the respective K-1s
– Arizona K-1s make net adjustments
– Non-residents only report Arizona source
income
• Report these amounts on the partner’s
individual tax return
• Apply the appropriate individual state tax rate
• Apply the applicable individual state tax credits
10. Who Is Subject To Taxation?
• Generally if you are doing business in a
particular state
• A state is subject to the limitations
imposed by the Due Process and
Commerce Clauses of the U.S.
Constitution
– Quill says there must be physical
presence
• If an LLC is subject to tax in more than
one state, those states must apportion
the tax burden among themselves
11. Arizona Apportionment Rules
They are generally based on the following
formula:
Arizona Property + Arizona Payroll + o Arizona Sales Total Income
2 o
Total Property Total Payroll Total Sales X p/s = taxable
income by
4 Arizona
– This is the current Arizona version of the
traditional UDITPA three factor formula
12. Apportionment Is Based
On Two Concepts
• Business Income
• Non Business Income
– Business income arises “from
transactions and activity in the regular
course of the taxpayers business . . .”
– Non business income is “all income
other than business income”
13. Apportionment Is Based
On Two Concepts
• Business income is apportioned
among the states where the
taxpayer engages in business
• Non business income is generally
allocated to the one state where the
income is generated
14. Non Business Income
• Non business income consists of:
– Rents
– Royalties
– Capital Gains
– Patent Royalties
– Copyright Royalties
– Dividends
– Interest
15. Business Income
• Business income consists of all income
arising from the taxpayer’s regular
business activity
• It is apportioned among all of the states
where the taxpayer is doing business
based on the percentage of three factors
from the above formula:
– The property factor
– The payroll factor
– The sales factor
16. The Property Factor
• The percent of the taxpayer’s total
property that is in Arizona
– Does not include intangible property
– The value of the property is its original
cost as adjusted for improvements and
dispositions but not depreciation
– If leased, the value is eight times the
annual rent
– Property used to produce nonbusiness
income is nonbusiness
17. The Payroll Factor
• The percent of the taxpayer’s total
payroll that is in Arizona
– Only what is paid to employees, not
independent contractors
– Applies to services performed entirely or
mostly in Arizona
18. The Sales Factor
• The percent of the taxpayer’s total
sales that are in Arizona
• Sales includes sales but also:
– Services
– Leasing
– Licensing
– Etc.
19. There are different rules for sales of
tangible and intangible property
• Tangible Personal Property
– Arizona uses the “destination” rules for sourcing
TPP
– A sales is Arizona source if it is shipped into
Arizona
– The “throwback” rules have been repealed
• Intangible Personal Property
– It is Arizona source if:
• The income producing activity is in Arizona, or
• Most of the income producing activity is in
Arizona
• See Heller Western
20. Miscellaneous
• There are rules that allow alternative
methods or factors to be used
• Many states, although not Arizona (with
one exception), have special
apportionment formulas for certain
industries (banks, railroads, publishing)
21. In Summary
• An LLC will be taxed by Arizona under the federal
rules with certain Arizona adjustments
• An LLC or group of LLCs can be taxed by all of the
states in which they are doing business or
physically present
• An LLC or group of LLCs can be taxed by states
where they are not doing business or physically
present if one of the LLCs is doing business or
physically present and the others are unitary
• The total income of the LLC or LLC group will be
apportioned among the states where they are
subject to tax
22. The Corporation Rules
• The old law—Arizona had its own
independent corporate tax code
• Now—Arizona taxable income “piggy
backs” from federal income—the federal
“flows through” to the state
– Federal taxable income equals Arizona
gross income
23. The Corporation Rules
• Make the statutory additions and
subtractions
• The result at this point is Arizona taxable
income
• Apply the corporate income tax rate of
6.968% of the taxable income
• Apply the applicable corporate state tax
credits
• Be aware of special state rules for certain
types of corporations
24. The Unitary Concept
• Even though, for example, only one LLC may
be physically present or doing business in
Arizona, related entities may contribute to the
income produced in Arizona.
• Under the unitary theory, Arizona may tax the
total (apportioned) income of all of the related
entities.
• The related entities must be unitary—effectively
operating as a single unit (an “organic whole’)
for business purposes.
• In Arizona, the test is “operational integration”
– Contrast with California’s “functional integration”
• Arizona has a big regulation on point.
25. The Unitary Concept
• In Arizona, the limit on taxing is “water’s
edge”
– Contrast with California’s “world wide”
combined reporting.
26. The Individual Rules
• Same as the partnership, except:
– Federal adjusted income equals Arizona
gross income
• Make the individual statutory additions
and subtractions
• Report this amount on the individual tax
return
• Apply the appropriate individual state tax
rate
• Apply the applicable individual state tax
credits
27. State Tax Traps
• City Speculative Builder Tax
• Transfers of Assets
• Intercompany Leasing
• Property Tax Exemptions
• Property Tax Affidavits of Value
• Successor Liability
• Multistate Taxation
28. Partnerships, LLCs and LLPs:
Organization And Operation In Arizona
Presented by
Mike Galloway
Member
Bancroft Susa & Galloway, PC
www.arizonatax.com
Bancroft Susa & Galloway
A PROFESSIONAL CORPORATION
