Earlier this year, Kansas enacted legislation that repealed a statute requiring flowthrough entities to withhold income from nonresidents.1 This legislation is an outgrowth of 2012 legislation that exempted, from Kansas personal income taxation, non-wage business income for S corporations, partnerships and limited liability companies (LLCs).
Subtraction Modifications for Non-Wage Business Income
For taxable years beginning after December 31, 2012, Kansas enacted legislation that exempts "non-wage business income" from the personal income tax pursuant to three related subtraction modifications, to the extent such items were included in the taxpayer's federal adjusted gross income.2
Taxpayers claiming the subtraction modifications are excluded from receiving a credit for taxes paid to other states on the excluded income. Depending on the state, the flowthrough income could be subject to tax by the individual's resident home state. In addition, a series of addition modifications was enacted that prevented individuals from claiming losses or deductions associated with these categories of income.3
Schedule C Net Profits
A subtraction from federal taxable income is available for the net profit of a business as determined under the federal Internal Revenue Code (IRC) and reported from Schedule C and on line 12 of the taxpayer's Form 1040, U.S. Individual Income Tax Return.4 Income not properly reported in accordance with federal income tax law and instructions on Schedule C and line 12 of Form 1040 is outside the scope of the subtraction modification language in the Kansas statute.5 Under federal law, Schedule C is available only to sole proprietors, to single member LLCs not treated as separate entities for federal income tax purposes, and to individuals considered statutory employees for federal income tax purposes.6 Statutory employees receive a Form W-2 with the "statutory employee" designation box checked on the form. Because they are not allowed to use Schedule C, employees who receive wages reported on federal Form W-2 (other than statutory employees) will not qualify for the business income exemption.7
Schedule E Net Income
A second subtraction is provided for the net income from rental real estate, royalties, partnerships, S corporations, estates, trusts, residual interest in real estate mortgage investment conduits (REMICs), and net farm rental as determined under the federal IRC and reported from Schedule E and on line 17 of the taxpayer's Form 1040.8 In order to qualify for this subtraction modification, the income must be allocated to an individual as pass-through income from a partnership, S corporation, or conduit income from an estate or trust. Similar to the first subtraction modification, income not properly reported in accordance with federal income tax law and instructions on Schedule E and on line 17 of Form 1040 is outside the scope of the subtraction modification language of the Kansas statute.9
Schedule F Net Farm Profit
Finally, a third subtraction is provided for the net farm profit as determined under the IRC and reported from Schedule F and on line 18 of the taxpayer's Form 1040.10 Again, income not properly reported in accordance with federal income tax law and instructions on Schedule F and on line 18 of Form 1040 is outside the scope of the subtraction modification language of the Kansas statute.11
Elimination of Nonresident Withholding by Flow-Through Entities
Effective July 1, 2014, the recently enacted legislation addressed the effect of the second subtraction modification with respect to individual owners of pass-through entities by repealing nonresident withholding requirements for S corporations, partnerships and LLCs. Specifically, these flow-through entities were previously required to deduct and withhold tax from a nonresident's share of the flow-through entity's Kansas taxable income, whether distributed or undistributed, and pay the withheld amount to the Kansas Department of Revenue.12
Commentary
In 2012, as part of what was thought to be a long-term strategy to reduce the overall personal income tax burden, Kansas enacted the above subtraction modifications, while reducing personal income tax rates, modifying the tax bracket system and increasing the standard deductions for individuals.13 While some of these changes were amended and scaled back in 2013,14 the repeal of the nonresident withholding requirements in 2014 may create some refund opportunities. If any income tax was withheld from a nonresident shareholder, partner or member of a flow-through entity during the 2014 tax year, the nonresident shareholder, partner or member can file a 2014 income tax return and claim a refund.
Some questions have arisen concerning application of the statute providing the exemption for non-wage business income, including whether such exemption impacts nonresidents any differently than Kansas residents, and whether a nonresident S corporation shareholder's Kansas business income is exempt from Kansas income tax. Based on the statute, the new law is intended to treat residents and nonresidents equally. Therefore, income that is exempt for a Kansas resident should also be exempt for a non-Kansas resident.
As for whether the nonresident needs to file a Kansas tax return if such income is the only source of Kansas income, the Kansas Department of Revenue has not issued any ruling or policy statement on this issue. Accordingly, a nonresident receiving income from Kansas sources must still file a Kansas income tax return regardless of whether tax will be due.15
Footnotes
1 S.B. 265, Laws 2014, repealing KAN. STAT. ANN. § 79-32,100e. This legislation was effective July, 1, 2014. However, in most cases, it became effective immediately upon the governor's signature on April 17, 2014 because withholding would not be reported until the end of the year.
2 Ch. 135 (H.B. 2117), Laws 2012, enacting KAN. STAT. ANN. § 79-32,117(c)(xx).
3 KAN. STAT. ANN. § 79-32,117(b)(xix).
4 KAN. STAT. ANN. § 79-32,117(c)(xx).
5 Notice 12-11, Kansas Department of Revenue; Revenue Ruling 19-2012-02, Kansas Department of Revenue, Aug. 30, 2012. 6 Instructions, Schedule C (Form 1040). Statutory employees include full-time life insurance agents, certain agent or commission drivers and traveling sales persons, and certain people working from home.
7 Notice 12-11, Kansas Department of Revenue; Revenue Ruling 19-2012-02, Kansas Department of Revenue, Aug. 30, 2012.
8 KAN. STAT. ANN. § 79-32,117(c)(xx).
9 Notice 12-11, Kansas Department of Revenue; Revenue Ruling 19-2012-02, Kansas Department of Revenue, Aug. 30, 2012.
10 KAN. STAT. ANN. § 79-32,117(c)(xx).
11 Notice 12-11, Kansas Department of Revenue; Revenue Ruling 19-2012-02, Kansas Department of Revenue, Aug. 30, 2012.
12 Former KAN. STAT. ANN. § 79-32,100e.
13 Ch. 135 (H.B. 2117), Laws 2012.
14 H.B. 2059, Laws 2013. For further information on this legislation, see GT SALT Alert: Kansas Enacts Tax Rate Reduction Legislation.
15 KAN. STAT. ANN. § 79-3220(d).
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