Alabama Pass Through Entity Tax: Everything You Need to Know
Alabama pass through entity tax is applied to any partnership or other entity that is classified as a Subchapter K entity.3 min read
Updated November 18, 2020:
Alabama pass-through entity tax is applied to any partnership or other entity that is classified as a Subchapter K entity. This does not include estates, trusts (excluding those related to non-resident members), business trusts, or single-member limited liability companies. The pass-through entity must file an annual return with the Alabama Department of Revenue for each taxable year.
A composite income tax return must be filed for any non-resident members, and the pass-through entity must also report and pay the income tax. They must apply the highest income tax rate on each nonresident entity's share.
A pass-through entity must provide a tax return that shows the total amount paid or credited to its nonresident members. A pass-through entity is also required to provide its nonresident members with a record of Alabama income tax remitted to the Alabama Department of Revenue.
Terms Related to Pass-Through Entity Tax
When reviewing the tax code, it is important to fully understand the terms that are used. In the 2013 code of Alabama, a member is defined as one of the following:
- An individual, estate, trust, or business trust.
- A corporation.
- A Subchapter K entity including a limited, general, limited liability, limited liability partnership, or limited liability company.
A nonresident member is:
- A person who has not been a resident in the state during the tax year.
- A foreign corporation that has acted commercially but has not been in the state during the tax year.
- A Subchapter K entity that was not formed in Alabama and has not acted commercially in the state during the tax year.
A pass-through entity is:
- Classified as Subchapter K and is a partnership or other entity.
- Does not include estates, trusts, or business trusts.
A qualified investment partnership is a partnership or entity classified as Subchapter K or a business trust that meets these requirements:
- Qualifying investment securities, office facilities, and tangible personal property needed to carry out the entity's activities in Alabama cannot be lower than 90 percent of the cost of the total assets of the entity.
- Interest, distributions, dividends, and gains and losses from the exchange or sale of qualifying investment securities and fees for management that are paid by the members must be 90 percent or more of the entity's gross income.
- An authorized partner, member, officer, or manager of the entity must file a certification showing it meets the criteria in regard to the tax period covered by the certification, at the time and in a form determined by the Department of Revenue.
Qualifying investment securities are described as:
- Common stock and preferred stock.
- Debentures, bonds, and additional debt securities.
- Deposits and other bank or financial institution obligations.
- Any interests that qualify as an investment partnership.
- Any additional financial or investment contracts, securities, or instruments.
Proposed Regulations 810-3-24.2-.01 & 810-3-24.2-.03
Under proposed regulation 810-3-24.2-.01, pass-through entities can choose the option to reduce their composite payment because a nonresident member made the required yearly tax payments and necessary filings.
Qualified investment partnerships that have a nonresident member are usually exempt from paying income tax in Alabama as long as the nonresident member does not act as management within the partnership. A composite return is due for a qualified investment partnership only if it is required to submit a composite payment for at least one of its nonresident members. According to the proposed regulation, the qualified investment partnership must file an Alabama partnership tax return annually with the required K-1 information for each nonresident or resident member who holds an interest at any time during the tax year.
In addition, Proposed Regulation 810-3-24.2-.03 states the nonresident members of a qualified investment partnership that received income from an Alabama source are required to file an Alabama income tax return. Any nonresident member of a qualified investment partnership should file the Alabama income tax return as a way to document and set a record of net operating losses from the qualified investment partnership.
An Alabama income tax return must be completed even if a composite return was filed referencing the same Alabama-sourced income. The only caveat to this rule is if the nonresident member's Alabama source income is only from the qualified investment partnership. In this scenario, the Alabama income tax return is not required.
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