any states, in order to collect revenue without having to pursue nonresidents for it, have begun requiring flow-through entities (for example, S corporations, partnerships and limited liability companies (LLCs)) to either withhold taxes or pay estimated taxes on behalf of their nonresident shareholders, shareholders, partners and members (owners), respectively. This requirement can create economic, contractual, statutory and administrative problems for CPAs and their clients, and so is worth scrutiny.
Many agreements call for distributions based on the “class” of owner. A violation of the agreement may occur if the entity must make distributions on behalf of certain shareholders/partners/members due to their status as nonresidents before making distributions to those with a higher priority.
However, the entity’s cash flow may be inadequate to permit distributions to all shareholders. Some tax advisers treat the tax payments as loans to the nonresident owners, which they can repay either from future distributions or directly. The treatment of payments also varies from state to state.
For more information, see the Tax Clinic, edited by Allen Beck, in the October 2003 issue of The Tax Adviser.
—Lesli Laffie, editor