All about business November 2019 Tax News
California Group Nonresident Return (aka Composite Returns) - Part 2
In our August 2019 All About Business article, we touched on a business entity’s ability to file a group/composite return on behalf of its nonresident individual:
Rather than each of the above having to file a California Nonresident or Part-Year Resident Income Tax Return (Form 540NR).
In this article, we will discuss issues to bear in mind if your client is considering making this irrevocable election to file a nonresident group return on behalf of its electing nonresident individuals.
California law imposes a tax on the income of a nonresident taxpayer that is derived from or attributable to sources within this state. However, a group nonresident return may be filed by:
- A business entity, acting as the authorized agent for its electing nonresident individual shareholders/partners/members, to report the distributive shares of income from the business entity derived from California sources or from doing business in California.
- A corporation, acting as the authorized agent for its electing nonresident directors, to report the directors’ wages, salaries, fees, or other compensation from that corporation for director services performed in California, including attendance of board of directors’ meetings in California.
In other words, the business entity/corporation files the return and pays the tax on behalf of the electing nonresident individuals. A group nonresident return is considered a group of individual returns that meets the California individual income tax return filing requirement. Thus, a qualified nonresident individual who elects to be included in the group nonresident return does not file a separate personal income tax return for the tax year.
However, the electing nonresident individuals and the business entity/corporation need to consider that filing a group Form 540NR return (composite return) in California subjects the nonresident income to the highest marginal rate and therefore does not allow the taxpayer to take advantage of lower graduated rates. For taxable years beginning on or after January 1, 2012, the maximum personal income tax rate increased to 12.3%. The nonresident individuals with over $1 million of California taxable income are eligible to be included in group nonresident returns, however, an additional 1% mental health services tax will be assessed on their entire California taxable income if they elect to be part of the group return. As a result, these nonresident individuals will pay tax at a rate of 13.3%, the top personal income tax bracket.
In addition, filing a group Form 540NR return prevents the taxpayers from taking advantage of some deductions or credits that they may otherwise have been able to use. Individual deductions are not allowed on the group nonresident return. On the group nonresident return, no deductions or credits are allowed except those directly attributable to the business entity’s activity. Individual deductions include, but are not limited to, the deduction for self-employment tax, the IRC Section 179 deduction, charitable contributions, itemized deductions, and the standard deduction. However, there is an exception for the deduction for contributions to a deferred compensation plan. Partners of a partnership and members of an LLC (but not shareholders of an S corporation) are allowed a deduction on the group nonresident return under IRC Section 401 through Section 424, as modified by California. However, if an electing nonresident individual has earned income from any other source, no deduction is allowed.
A Net Operating Loss (NOL) is also an individual deduction. Consideration should also be given if there are NOLs. An individual cannot claim an NOL deduction on the group nonresident return. An individual who reports a net loss on the group nonresident return forgoes any NOL carryover that could have resulted on an individual nonresident return from that net loss.
Credits that can be claimed on the group nonresident return are credits that are directly attributable to the business entity’s activities such as the new employment credit, the low-income housing credit, and the research credit.
Individual credits, such as the personal, blind, senior, or dependent exemption credits and the other state tax credit, are not allowed on the group nonresident return.
For more information on Credit limitations go to Publication 1067, Guidelines for Filing a Group Form 540NR, Section F, Individual’s Decision to be Included in the Group Nonresident Return.
Moving estimated payments
You may need to move estimated tax payments “from the group nonresident return to the individual nonresident return” or “from the individual nonresident return to the group nonresident return.”
Schedule 1067B – Use Schedule 1067B, Group Nonresident Return Payment Transfer Request, to authorize us to move estimated tax payments. This form is included with our Publication 1067, Guidelines for Filing a Group Form 540NR.
In order for withholding to be credited to a nonresident group return, the proper Form 592 showing the allocation of these withholding credits needs to be filed. If Form 592 is not filed, withholding may not be properly credited to the group nonresident return.
If the withholding credit was not allocated to the nonresident group return, you will need to use Schedule 1067A, Nonresident Group Return Schedule, to allow us to move withholding credits to the group.
Time period to move the payments – Once a request is received, it takes six to eight weeks to move the estimated tax payments and/or withholding credits and have them available to be claimed on the return. You should allow sufficient time for the transfers to take place before filing the group or individual returns.
The election to be included in the group nonresident return is irrevocable – If your clients are considering this option, inform individuals being included in the group that once the group nonresident return is filed, it cannot be amended to either include or exclude a nonresident individual.