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Does Your Law Firm Operate in Multiple States?

Does Your Law Firm Operate in Multiple States?

If this is the case, beware of your personal income tax responsibilities. If your K-1 shows non-resident state income taxes paid, be sure you understand how to report the taxes. The United States Tax Court opined on April 9, 2015 (T.C. Memo. 2015-73), on the matter of Matthew Cutler and Shannon Cutler v. Commissioner of Internal Revenue.
This matter related to non-resident state income taxes paid by the firm. Cutler argued that the taxes paid were unreimbursed partnership expenses; that they were entity-level taxes imposed directly on the firm and not the individual, and should be reported on Schedule E. The benefit derived from this scenario is a reduction in self-employment taxes and if the taxpayer is subject to AMT, potential additional benefits.

The Court disagreed with Cutler and opined that the taxes were imposed on the net income of the partner and not the firm; the Court also stated that because Cutler was a Principal in the firm and had authority to manage the firm’s business in those states, he specifically had nexus in those non-resident states and is required to report such taxes on Schedule A as an itemized deduction.

This determination states that the non-resident state taxes in question are not deductible from gross income in determining AGI but are only deductible as itemized deductions.

For state and local tax purposes, consider that the non-resident state income taxes paid may result in a credit on your resident state and local tax returns as a “tax paid to other jurisdictions”.

Author: Bill Stahl | bstahl@withum.com

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