BEFORE THE Department of REVENUE

OF THE STATE OF MONTANA

 

In the matter of the adoption of New Rules I and II and the amendment of ARM 42.9.101, 42.9.102, 42.9.103, 42.9.104, 42.9.105, 42.9.106, 42.9.501, 42.9.510, and 42.9.520 pertaining to pass-through entities

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NOTICE OF ADOPTION AND AMENDMENT

 

TO: All Concerned Persons

 

1. On October 15, 2015, the Department of Revenue published MAR Notice No. 42-2-941 pertaining to the public hearing on the proposed adoption and amendment of the above-stated rules at page 1694 of the 2015 Montana Administrative Register, Issue Number 19.

 

2. On November 4, 2015, a public hearing was held to consider the proposed adoption and amendment. No members of the public attended the hearing. Written comments were received from Jane Egan, Executive Director of the Montana Society of Certified Public Accountants, and Lindsay N. Sander, State Affairs, Master Limited Partnership Association.

 

3. The department adopts New Rule I (42.9.108) and New Rule II (42.9.109) and amends ARM 42.9.101, 42.9.102, 42.9.103, 42.9.104, 42.9.105, 42.9.106, 42.9.510, and 42.9.520 as proposed.

 

4. Upon further review, the department determined that Form PT-AGR will provide the necessary information regarding resident-owned single member LLCs holding an interest in a pass-through entity, making a portion of the proposed amendments to ARM 42.9.501 unnecessary. Therefore, the department amends ARM 42.9.501 as proposed, but with the following changes from the original proposal, new matter underlined, deleted matter interlined:

 

42.9.501  PASS-THROUGH ENTITY INFORMATION RETURNS FOR SINGLE-MEMBER LLC TREATED AS DISREGARDED ENTITY  (1)  Any single-member limited liability company (LLC) treated as a disregarded entity that has Montana source income, whether formed in Montana or in another state or country, must file a Montana Disregarded Entity Information Return, Form DER-1, as provided in this rule unless:

(a)  the sole member is an individual who has been a full-year Montana resident during the applicable reporting period. ; and

(b)  the single member LLC itself does not hold an interest in a pass-through entity.

(2) through (13) remain as proposed.

 

5. The department has thoroughly considered the comments and testimony received. A summary of the comments received and the department's responses are as follows:

 

COMMENT 1: Lindsay N. Sander, State Affairs, Master Limited Partnership Association (Association), advised that the Association has worked with the department over the last several years to address issues posed by both statutory and regulatory requirements for master limited partnerships (MLPs). She stated that, as a result, the proposed changes to ARM 42.9.106 establish a process for MLPs to apply for a waiver from second-tier reporting requirements.

Ms. Sander further commented that the Association appreciates the department's willingness to work through issues and establish an exemption process for MLPs while meeting the needs of the department.

 

RESPONSE 1: The department appreciates Ms. Sander's comments and support of the rule amendments.

 

COMMENT 2: Jane Egan, Executive Director of the Montana Society of Certified Public Accountants (MSCPA), commented that in the MSCPA's opinion, the department is writing new laws, not rules. All state agencies are limited by law to the passing of regulations that enable legislation as enacted. The Montana Supreme Court has stated that administrative rules may not limit the law in any way; they may only enable the laws as written. The Court has ruled on several occasions that passing legislation is a constitutional power reserved for the Montana Legislature. 

Ms. Egan further commented that this whole new set of rules mandates a 100 percent audit of LLC taxpayers without an act of the legislature.  In general, the MSCPA feels the proposed rules and amendments are an overreach by the department and that the department is placing an enormous burden on small entities. The new rules and proposed amendments are unconstitutional and unnecessarily burdensome and therefore the MSCPA asks the department to "kill" the proposed new rules and amendments.

 

RESPONSE 2: The department appreciates the comments from Ms. Egan and the members of the MSCPA, but respectfully disagrees with their belief that the proposed rules violate Montana law.  The department is statutorily required to adopt rules that "set forth the nature and requirements of all formal and informal procedures available."  Section 2-4-201(2), MCA.  Moreover, several other statutory provisions found in Title 15 of the Montana Code Annotated, including 15-30-3313, MCA, specifically authorize the department to adopt rules to administer the provisions of Montana's tax code. Given the complexity of state tax issues facing pass-through entities and the administrative challenges in administering those provisions in a fair and equitable manner, the department believes the rules as proposed provide necessary guidance to taxpayers and their representatives.

 

COMMENT 3: With regard to proposed New Rule I, the MSCPA commented that the requirement to file an affidavit by the taxpayer, stating there is no activity, is not dissimilar to filing a return with no activity. This is an overreach by the department. Under a tax system of voluntary compliance, a taxpayer should not have to affirm the absence of a filing requirement. The MSCPA further commented that proposed New Rule I should be stricken in its entirety.

 

RESPONSE 3: New Rule I is intended to provide guidance to inactive pass-through entities. The department proposed this new rule to establish a requirement for information to assist the department in determining the business purpose and filing requirements of registered limited liability companies and partnerships. More than 12,000 entities are registered with the Secretary of State each year. The department is tasked with following up on each one to determine if a filing obligation exists. Through various compliance processes, the department requests and receives signed statements from entities that do not have a filing requirement.  As proposed, New Rule I will proactively require this information on an ongoing, more current basis, which should streamline certain processes where the taxpayer needs a determination of good standing from the department.

 

COMMENT 4: With regard to proposed New Rule II, the MSCPA questions why a simple copy of the IRS determination letter would not accomplish the same result and commented that this proposal is burdensome, unfriendly, and discouraging. This is documentation that should only be provided if the department performs an audit. The names on the K-1s provide enough information for the department to determine a tax-exempt entity. As proposed, New Rule II places a policing function on the taxpayer to ensure that other taxpayers are compliant through the withholding process. This appears to be an attempt to be able to create a penalty assessment for noncompliance. A simple solution would be to require a Form 5500 filing and cross-reference the K-1s.

 

RESPONSE 4: The requirements for exempt organizations are outlined in the department's rules covering corporation license taxes in ARM 42.23.103. The department is reiterating those requirements in proposed New Rule II for the benefit of the owners in pass-through entities that are considered tax-exempt.  Generally, the department requires the tax-exempt entity to apply for tax-exempt status in the state separately from their federal request by filing Montana Form EXPT, Tax Exempt Status Request Form. The department currently requests documentation to establish the entity's status as tax-exempt and sends a state-specific exemption letter.  The department regularly encounters owners in pass-through entities that are tax-exempt entities and deemed it appropriate to also provide these requirements in ARM Title 42, chapter 9, which covers pass-through entities.

 

COMMENT 5:  The MSCPA recommended changing ARM 42.9.104(1) and 42.9.106(1) to a distributive share of source income of $15,000 or more, rather than $1,000, as this is the highest Montana personal rate which would arrive at a tax of roughly $1,000.  They commented that ARM 42.9.104(7)(a) and (b) and 42.9.105(7)(a) and (b) should be stricken because those provisions would require taxpayers to police each other.

 

RESPONSE 5: The threshold of $1,000 provided for in ARM 42.9.104(1), 42.9.105(1), and 42.9.106(1) is in accordance with 15-30-3313(1), MCA, as revised by Senate Bill 386, L. 2015, which eliminated a pass-through entity's requirement to withhold on its nonresident members, partners, or shareholders when their distributive share is less than $1,000.

The provisions proposed in ARM 42.9.104(7)(a) and (b), 42.9.105(7)(a) and (b), and 42.9.106(9)(a) and (b) establish that withholding will not be assessed if the owner has filed and paid taxes when due. However, the entity may still be liable for penalties and interest if a requirement to withhold existed.  The department will hold the pass-through entity liable for penalties and interest on an amount they were required to withhold but didn't (e.g., did not include nonresident owner on composite return and did not have a valid Form PT-AGR for the owner), even though the owner filed and paid taxes.  This is an intended penalty on the pass-through entity for not following the withholding requirements.  A significant number of entities are not following the law. Many entities are doing the same thing year after year even after the department has informed them of the requirements and what they can do to receive a waiver.

 

COMMENT 6: With regard to the proposed changes to ARM 42.9.106(2), the MSCPA proposed replacing the new language in (a), (b), and (c) with the following: "The department will waive the requirements to remit tax or pay composite tax if the first-tier pass-through entity files Form PT-AGR."

 

RESPONSE 6: As proposed, the new language in ARM 42.9.106(6)(a), (b), and (c) expressly outlines the requirements for obtaining a waiver for a "domestic second-tier pass-through entity."  The waiver is not automatic by the mere filing of the Form PT-AGR. However, it is considered valid if the prescribed information is received.  These requirements are outlined in accordance with 15-30-3313(8), MCA, as revised by Senate Bill 386 and adopted by the 2015 legislature.  A revised Form PT-AGR will provide space to report information about the owners of the "domestic second-tier pass-through entity."

 

COMMENT 7: The MSCPA proposed striking ARM 42.9.501(13) because this filing requirement seems redundant as the Montana source income would be properly reported on the individual's Montana income tax return even if they are a nonresident.  An owner of a single member LLC does not have ongoing filing requirements with the IRS.

 

RESPONSE 7: The filing requirements for disregarded entities are statutorily provided in 15-30-3302(5)(c), MCA, and are outlined in ARM 42.9.501(1) through (11). ARM 42.9.501(13) addresses late filing penalties for late filed Disregarded Entity Information Returns (Form DER-1) and is an appropriate provision to maintain in rule.  Furthermore, based on the late file penalty provisions outlined in 15-30-3302(5)(d), MCA, a single member LLC would not be assessed a late filing penalty if the owner filed a timely return, regardless of whether that owner is a resident or nonresident. In other words, the disregarded entity is only assessed a late filing penalty if both the entity and the owner file untimely.

COMMENT 8: The MSCPA proposed striking ARM 42.9.510 in its entirety because if a taxpayer is making an election under IRC 761, their intent is to simplify their future filing requirements and the department has the necessary information from the initial or final filing.

 

RESPONSE 8:  Entities that are disregarded for federal purposes are not disregarded for state purposes. Disregarded entities are required to file an information return in accordance with 15-30-3302(5)(c), MCA.  The current filing requirements and deadlines for entities electing to be disregarded under IRC 761 prevent the department from consistently applying the withholding requirements outlined in 15-30-3313, MCA.

 

 

/s/ Laurie Logan                                    /s/ Mike Kadas

Laurie Logan                                         Mike Kadas

Rule Reviewer                                       Director of Revenue

 

         

Certified to the Secretary of State November 30, 2015