Maine Denies Owner a Tax Credit for New Hampshire Taxes Paid by Business

When a non-resident individual owns and operates a pass-through entity in a state that imposes entity-level taxes, the owner’s resident state may not provide a personal income tax credit according to a recent Maine Supreme Judicial Court opinion.

By Tina M. Chunn, SALT senior manager

When a state recognizes S corporations, LLCs and partnerships as pass-through entities (“PTE”) for income tax purposes, the individual shareholders, members and partners are taxed directly on their proportionate share of income earned in each state in which the PTE does business.  In their state of residence, the individual taxpayers receive a credit for any taxes paid on their share of income taxed by other states.[1]

However, when a state does not recognize the entity as an PTE and subjects it to a separate entity-level tax, the tax is still ultimately borne financially by the individual owners.  In this case, the question frequently arises as to whether the taxpayer may take a personal income tax credit in the state of residence for any entity-level tax imposed by another state.  On Aug. 2, 2018, the Maine Supreme Judicial Court ruled on this issue concerning a Maine resident taxpayer seeking a personal income tax credit for New Hampshire taxes paid by an LLC in which the taxpayer owns an interest.[2]

The taxpayers, James and Ann Goggin, are full-time residents in Maine and file joint federal and Maine income tax returns.  Ann owned an interest in a limited liability company (“GHK”) formed in 1994 to own, develop, maintain and lease a parcel of commercial real estate in New Hampshire.  GHK was classified as a partnership for federal income tax purposes for the years 2012 to 2014.  During these years, GHK received rental income and allocated a percentage of the profits and losses to Ann based on her ownership interest.

The State of New Hampshire does not impose income tax on individuals; however, it does impose a business profits tax and a business enterprise tax on entities, including LLCs.[3]  On its federal partnership return, GHK took a deduction for the New Hampshire business taxes paid against its real estate rental income.  Ann’s proportionate share of rental income was calculated using the net amounts after the deduction for reporting purposes on her Schedule K-1.  The taxpayers reported these net amounts on their individual federal and Maine income tax returns.

In January 2016, the taxpayers filed amended Maine income tax returns for 2012, 2013 and 2014, claiming a Maine personal income tax credit for their proportionate share of the New Hampshire business tax paid by GHK.  Those refund claims were denied, and the taxpayers appealed.

Maine’s law provides residents a tax credit as follows:

A resident individual is allowed a credit against the tax otherwise due . . . for the amount of income tax imposed on that individual for the taxable year by another state of the United States, a political subdivision of any such state, the District of Columbia or any political subdivision of a foreign country that is analogous to a state of the United States with respect to income subject to tax under this Part that is derived from sources in that taxing jurisdiction. . . . [4]

The issue is whether the New Hampshire business taxes paid by the LLC constitute an “income tax imposed on an individual.”  The taxpayers argued that New Hampshire’s business taxes are functionally imposed on the individual based on the flow-through nature of income from an LLC, and that the state’s formalistic interpretation of the language leads to double taxation.  The court rejected the taxpayer’s position, concluding that the phrase “income tax imposed on an individual” could not be interpreted to include New Hampshire’s business taxes.  New Hampshire imposes its business profits tax and business enterprise tax on an LLC’s taxable business profits and taxable enterprise value, respectively.[5]

Finally, the taxpayer argued that Maine’s interpretation is unconstitutional because the Commerce Clause prohibits failure to provide individuals credit for taxes paid to other states. However, the New Hampshire tax is explicitly imposed on and paid by the business entity and not the individual.  The Court affirmed that Maine does not violate the Commerce Clause as it does provide individuals credit for taxes paid to other states and the individual is not required by the Commerce Clause to receive a credit for taxes imposed on and paid by the business entity.

It is worth noting that while Georgia, like Maine, does not provide an income tax credit to individual resident owners of a PTE for out-of-state income taxes imposed on and paid by a PTE, it does provide resident owners of PTEs an adjustment to their income in certain cases where the PTE pays an out-of-state income tax (e.g., the Texas Franchise Tax).[6]

Aprio’s SALT team has experience with state tax credits and adjustments, and can assist taxpayers to ensure that they understand the state income tax impact of doing business in multiple states and receive the appropriate income tax credits/adjustments for their multi-state income.  We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

Contact Tina Chunn at tina.chunn@aprio.com or Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the September 2018 SALT Newsletter.

[1] Depending on the tax rates in each of those states, the credit may not be dollar-for-dollar, and there may be other limitations as explained in another article in this newsletter.

[2] James Goggin et al. v. State Tax Assessor, 2018 ME 111, Docket No. BCD-17-459, 08/02/2018.

[3] N.H. Rev. Stat. Ann. § 77:3(I)(a) (2012); N.H. Rev. Stat. Ann. § 77-A:2, 77-E:2 (2012).

[4] 36 M.R.S. § 5217-A.

[5] N.H. Rev. Stat. Ann. §§ 77-A:1(IV), N.H. Rev. Stat. Ann. §§ 77-E:1(III), (IX), 77-E:2 (2012).

[6] Ga. Code Ann. § 48-7-27(d)(1); Ga. Comp. R. & Regs. 560-7-4-.01(4).

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.