State and Local Tax Classifications of Pass-Through Entities – Should They be Uniform?

Bruce P. Ely
Bradley Arant Boult Cummings LLP
Birmingham

Readers who attended the Federal Tax Clinic in Tuscaloosa last November may remember a draft one-page chart in the materials that my indefatigable law partner, Robert Walthall, presented as part ofhis annual "Recent Developments in Alabama Taxes." That chart,prepared for in-house use by members of our firm, listed each form of pass-through entity and its state and local tax classification for income tax, sales/use tax, rental tax, license, ad valorem property tax, etc. For example, by statute, Alabama follows the IRS' "check-the-box" ("CTB")regulations for LLCs for all purposes, so that a single member LLC that is disregarded for federal tax purposes is likewise disregarded (i.e., treated as a division or Schedule C business)for income, sales/use, rental, state license and excise taxes, and generally, property taxes. However, LLCs are often treated as separate entities for local tax purposes, such as municipal business license taxes, depending on the taxing jurisdiction. Conversely, for limited partnerships,pending legislation, SB 87, amended at the request ofthe Alabama Department of Revenue, would limit federal/state conformity to only income taxes for LPs.

The same one-tax conformity rule applies to qualified Subchapter S subsidiaries ("Qsubs").It is likely, however, that LLPs follow the broader LLC paradigm, rather than the LP orQ-sub paradigm. And business trusts are taxed under Alabama law the same as federal but only for income tax purposes. They are treated as separate taxpayers for all other tax purposes.

We understand the ADOR wishes to unify or "harmonize" these tax classification rules, especially as they relate to property taxes. The ADOR has problems with single member LLCs especially in the latter area. We have also heard of a few CPA firms around the state who have misunderstood the rules (not surpisingly) and given incorrect tax advice to their clients. But hundreds if not thousands oftransactions, leases and contracts have been entered into based on our current law, especially with respect to LLCs. Certainly, there would have to be "grandfather" rules for existing contracts, leases, etc.-and a broad effort at educating tax practitioners before any law change went into effect. Your ASCPA President, Jeannine Birmingham, asked me to publish this article in order to solicit YOUR comments. Please email her at jbirmingham@ascpa.org or me at bely@ba-boult.com and let us know your comments and ideas on whether the tax classification rules should be made uniform among all business entities-by March 11. Yes, we know this is a terrible time of year to ask you to drop what you're doing and think about this issue, but your State Society is member-driven and needs your input. Thanks.