State Filings, Composite Returns and Nonresident Withholding
The part of syndication investing that nobody mentions at subscription and everybody discovers in the spring, when the K-1 arrives with a schedule listing states.
Investors focus on federal tax and are surprised by the states. A partnership that owns property in a state generally sources income to that state, and income sourced to a state can create a filing obligation for the partners there — regardless of where they live.
For one syndication in one state, this is a modest administrative matter. For an investor with five positions across five states, it accumulates.
Where the obligation comes from¶
The partnership itself files where it operates. Separately, each partner's share of income sourced to a state can require that partner to file a nonresident return in that state, if it exceeds the state's threshold.
Thresholds, rates, forms and rules differ by state, and several states have no individual income tax at all — which is one reason property in those states is administratively simpler for investors, though it says nothing about the merits of the deal.
Where the obligation exists, it is triggered by the property's location and not by the entity's state of formation. A Delaware LLC owning an apartment building in another state sources income to the state where the building is.
The three ways it is handled¶
| Mechanism | What happens | What it means for you |
|---|---|---|
| You file yourself | You file a nonresident return in each state where income is sourced | Most control, most administrative work, and the deductions and credits available to an individual filer |
| Composite return | The partnership files one return covering electing nonresident partners and pays their tax | Simplest; often at the highest rate, with deductions and credits disallowed |
| Nonresident withholding | The partnership withholds and remits on your behalf | Not a substitute for filing in most cases; the withholding is credited against what you owe |
Composite returns, and the trade they represent¶
A composite return is a group filing made by the partnership for electing nonresident partners. It removes the need for those partners to file individually in that state.
It is genuinely convenient. It also frequently costs more, for a specific reason: composite filings commonly apply the state's highest marginal rate and disallow the personal exemptions, deductions and credits an individual filing could claim. For a partner whose income in that state is modest, the difference can exceed the cost of preparing a return.
There is also a knock-on effect at home. Your state of residence generally grants a credit for tax paid to another state on the same income, and the mechanics of claiming that credit differ where the tax was paid through a composite filing rather than by you. Whether the credit is fully available is state-specific.
Withholding¶
Several states require partnerships to withhold on income allocated to nonresident partners, at a stated rate, and to remit it.
Two things about it. It appears on your K-1's state schedule and is generally creditable against what you owe that state, so it is a prepayment rather than an additional cost. And it does not usually eliminate the filing obligation — you may still need to file in order to claim the credit or a refund.
A common experience is receiving a distribution smaller than expected because withholding was deducted, then discovering that the amount is recoverable through a filing that costs more to prepare than the amount at stake. That is annoying and it is not anybody's error.
The states that make this easier¶
Property location drives the obligation, and several states impose no individual income tax at all. A syndication owning property in one of them produces no nonresident filing obligation there, which removes the whole question.
That is an administrative fact rather than an investment thesis, and it is worth knowing when comparing two otherwise similar deals: one may cost you a return, a preparer's fee and a small tax bill every year, and the other may not.
It does not follow that deals in no-tax states are better. It follows that the administrative cost of holding a position is part of the total cost, that it varies, and that it is knowable before subscribing by asking one question about where income will be sourced.
What to establish before subscribing¶
None of this affects whether a deal is good. It affects the administrative cost of holding it, which is a real cost, and it is the part of syndication investing that surprises people most reliably in the first spring after they invest.
As with everything on this page: whether you have a filing obligation in a particular state, and what to elect, is a question for a tax professional licensed where you file. This article describes the mechanisms so that you know what to ask about. See also the K-1 itself and when it arrives.
Primary sources
Every factual claim above is traceable to a filing, a rule or an agency publication. These are the ones this article relies on.
Questions readers ask
Do I have to file a state return where the property is?
Often yes, if income is sourced to that state and exceeds the state's filing threshold. The rules and thresholds differ by state, and whether one applies to you is a question for your tax adviser.
What is a composite return?
A single state return filed by the partnership on behalf of electing nonresident partners, paying their state tax at the entity level so they do not have to file individually in that state.
Is a composite return better than filing myself?
It is simpler and can cost more, because composite filings often apply the highest marginal rate and disallow deductions, exemptions and credits an individual filing could use. Whether the trade is worthwhile depends on your figures.
What is nonresident withholding?
Some states require a partnership to withhold tax on income allocated to nonresident partners. The withheld amount appears on your K-1 state schedule and is generally creditable against the state tax you owe.
Can I get a credit at home for taxes paid to another state?
Most states of residence provide a credit for taxes paid to other states on the same income, subject to their own rules and limits. The mechanics vary and are worth confirming with a preparer.
Read next
- TaxThe Schedule K-1 a Syndication Sends You, Box by BoxThe form reports your allocated share of the partnership's income, deductions and capital. It will not match the cash you received, and it is not supposed to.
- TaxDepreciation, Cost Segregation and Bonus DepreciationA deduction requiring no cash outlay, accelerated into the early years. It changes the timing of deductions, not the total, and it enlarges recapture at sale.
- TaxPassive Activity Loss Rules: Why Your Losses May Be SuspendedThe rule that decides whether a syndication's first-year paper loss reduces your tax bill. For most W-2 investors, the answer is not this year.