Can Missouri-resident S corporation shareholders claim a resident credit for Missouri tax on income the S corporation earns in other states?

Subject

S Corporation Resident Credit

Plain-English summary

The Missouri Department of Revenue ruled that Missouri-resident shareholders of a Missouri S corporation ("Tax Entity") can claim the Section 143.081.3(2), RSMo, resident credit against their Missouri individual income tax for some, but not all, of the S corporation's out-of-state income.

Tax Entity is organized only in Missouri, has no physical presence elsewhere, and is treated as an S corporation everywhere it does business. It ships products into other states, some of which have no income tax at all, and it is also protected by federal Public Law 86-272 from income tax in other states that do have one. It also pays the Texas franchise tax on income sourced to Texas. The Taxpayers -- Missouri-resident individual shareholders -- had already claimed the 143.081.3(2) credit for their share of Missouri tax attributable to the Texas income and asked the Department to confirm their eligibility for the credit in two additional scenarios.

The credit under Section 143.081.3(2), RSMo, applies when (a) the S corporation's income originated in another state, political subdivision, or D.C.; (b) that income is subject to Missouri income tax under Chapter 143, either at the S-corp or shareholder level; and (c) the income is not subject to tax in that other jurisdiction, at either level.

The Department held that the Taxpayers are eligible for the credit in two situations: (1) when Tax Entity ships products into a state with no income tax at all (because item (c) is automatically satisfied -- there's no tax there to be subject to), and (2) when Tax Entity ships products into a state that does have an income tax, but PL 86-272 shields Tax Entity's income from that state's tax (because PL 86-272 protection also means the income is not "subject to tax" in that state, again satisfying item (c)).

The Department held that the Taxpayers are not eligible for the credit for income derived from Texas, because the Texas franchise tax is, in substance, an "income tax" for purposes of Section 143.081.3(2), RSMo -- even though Texas labels it a franchise tax. Applying the test from Herschend v. Dir. of Revenue, the Department found the Texas franchise tax is based on a taxable entity's margin computed from federal total revenue (citing Tex. Tax Code § 171.101), making it fundamentally an income tax and distinguishing it from the older Texas excise tax analyzed in Brennan v. Director of Revenue, which had both income and capital components. Because Texas income is "subject to tax" there (via the franchise tax), item (c) fails, and no credit is available for the Missouri tax on that Texas-sourced income.

What this means for you

Missouri-resident S corporation shareholders with multistate income

If your S corporation earns income in a state with no income tax, or is protected from another state's income tax by PL 86-272, this ruling indicates you may claim the Section 143.081.3(2), RSMo, resident credit for your share of the Missouri income tax attributable to that out-of-state income. But if your S corporation pays the Texas franchise tax (or a similar tax that functions like an income tax based on revenue or margin) on income sourced to another state, this ruling indicates that income will likely not qualify for the credit, because the other state's tax counts as an "income tax" that already reaches that income.

Accountants and tax professionals

When evaluating a Section 143.081.3(2), RSMo, resident credit claim for an S-corp shareholder, check all three requirements: the income must originate in another jurisdiction, be taxed by Missouri, and not be subject to tax in that other jurisdiction. Don't assume a state's own label for a tax is controlling -- apply the Herschend substance test to determine whether a state levy (like the Texas franchise tax) is functionally an "income tax," since that determination decides whether item (c) is met. A tax computed on margin or revenue (as under Tex. Tax Code § 171.101) is more likely to be treated as an income tax than an older-style excise tax with separate capital and income components (as in Brennan).

S corporations weighing PL 86-272 protection

This ruling confirms that PL 86-272 protection cuts both ways for resident shareholders: it shields the S corporation's income from another state's income tax, but that same protection is also what makes the income eligible for Missouri's resident credit, since the income ends up "not subject to tax" anywhere but Missouri.

Common questions

Q: Can Missouri S-corp shareholders get a credit for Missouri tax on income earned in a state with no income tax?
A: Yes. Because the other state has no income tax, the S corporation's income there is automatically "not subject to tax" in that jurisdiction, satisfying Section 143.081.3(2), RSMo's third requirement, so the resident shareholders can claim the credit for their pro rata share of the Missouri tax on that income.

Q: What if the other state has an income tax, but PL 86-272 protects the company from it?
A: The Taxpayers are still eligible for the credit. PL 86-272 protection means the income isn't actually subject to tax in that state (at either the S-corp or shareholder level), which satisfies the same "not subject to tax elsewhere" requirement.

Q: Why can't the Taxpayers get a credit for the Missouri tax on their Texas-sourced income?
A: Because the Department concluded the Texas franchise tax is, in substance, an income tax under the Herschend test -- it's computed from a taxable entity's margin based on federal total revenue. Since Texas does impose something the Department treats as an income tax on that income, the "not subject to tax in the other jurisdiction" requirement fails, so no 143.081.3(2) credit is available for the Texas-sourced income.

Q: Is the Texas franchise tax always treated as an income tax for Missouri resident-credit purposes?
A: This ruling treats the current Texas franchise tax that way, distinguishing it from the older Texas excise tax at issue in Brennan v. Director of Revenue, which had both income and capital components and was analyzed differently. The classification turns on how the tax is actually computed, not on what Texas calls it.

Q: Can another S corporation or shareholder rely on this ruling?
A: Not automatically. This is a Missouri letter ruling, binding on the Department only with respect to the requesting Applicants, only for three years from its date, and only so long as the facts and law remain unchanged. Anyone in a similar situation should confirm their own facts match and consult a tax professional.

Source

• Landing page: Missouri DOR Rulings Search
• Ruling: LR 8234

Original ruling text

Dear Applicants:

This is a letter ruling issued by the Director of Revenue under Section 536.021.10, RSMo, and Missouri Code of State Regulations 12 CSR 10-1.020, in response to your request dated January 8, 2023.

The facts as presented in your letter ruling request and in response to follow-up questions are summarized as follows:

Tax Entity is a Missouri S corporation and retailer. Tax Entity's base of operations is in Missouri, it is solely organized in Missouri, and it has no physical presence elsewhere.

The letter ruling request asserts that Tax Entity and its shareholders are sheltered from other states' and political subdivisions' income taxes under Federal Public Law 86-272 (" PL 86-272 "), but pay other taxes to a few of those states. The Texas franchise tax is among the taxes paid. Additionally, Tax Entity derives income from states that do not impose an income tax. Tax Entity is treated as an S corporation in all states where it derives income. Additionally, Tax Entity does not pay state corporate income tax as a C corporation in any state.

Applicants ("the Taxpayers") are Missouri residents and shareholders of Tax Entity. They have previously taken credits against Missouri's income tax for amounts paid towards Texas' franchise tax and no other credits have been taken for income originating in other states. The Taxpayers have submitted a letter ruling request asking for a determination of their eligibility to receive the Section 143.081.3(2), RSMo, tax credit ("143.081.3(2) credit" or "the credit").

ISSUE 1 :

Are the Taxpayers eligible to claim a 143.081.3(2) credit when Tax Entity ships products to another state that does not have an income tax?

RESPONSE 1 :

Yes, the Taxpayers would be eligible for the credit for their shares of Missouri income tax imposed on Tax Entity's income originating in other states without an income tax. However, the Texas Franchise Tax ("TFT") is considered an income tax for purposes of Section 143.081.3(2), RSMo, so a 143.081.3(2) credit is not allowed based on income derived from Texas. Section 143.081.3(2), RSMo, states that:

A resident S shareholder shall be eligible for a credit issued pursuant to this section in an amount equal to the shareholder's pro rata share of any income tax imposed pursuant to this chapter on income derived from sources in another state of the United States, or a political subdivision thereof, or the District of Columbia, and which is subject to tax pursuant to this chapter but is not subject to tax in such other jurisdiction.

Under Section 143.081.3(2), RSMo, a credit is permitted to a resident S corporation shareholder in the amount equal to the Missouri individual income tax imposed on the shareholder's pro rata share of the income from the S corporation, provided that the following items are satisfied:

(a)   The S corporation originated the income from sources in another state, political subdivision, or D.C.;

(b)   The income is subject to an income tax under Chapter 143, RSMo, either at the S corporation level or the individual shareholder level; and

(c)   The income is not subject to tax in the other jurisdiction, either at the S corporation level or the individual shareholder level.

Because the other states in this scenario lack an income tax, Tax Entity would not be subject to an income tax in those jurisdictions for purposes of Section 143.081.3(2), RSMo, meeting the requirements of item (c) in the paragraph above. With items (a) and (b) also being met, the Taxpayers are eligible for the 143.081.3(2) credit in this situation. This analysis does not apply to the Missouri income tax imposed on the Taxpayers for Tax Entity's income derived from Texas.

The TFT is an income tax for purposes of Section 143.081.3(2). The Taxpayers state that the TFT meets the test requirements set under Herschend v. Dir. of Revenue , 896 S.W.2d 458 (Mo. banc 1995). Despite the TFT being deemed a franchise tax by Texas law, the tax is based on a taxable entity's margin with their federal total revenue amount as the base of the calculation. Cf. Tex. Tax Code § 171.101. The TFT is fundamentally an income tax, at least for purposes of Section 143.081.3(2). The current TFT is significantly different from the Texas excise tax analyzed in Brennan v. Director of Revenue , 937 S.W.2d 210 (Mo. banc 1997), which at the time had both an income and a capital component. Because the TFT is an income tax, the Missouri income tax based on income derived by Tax Entity from Texas is not eligible for the credit.

ISSUE 2 :

Are the Taxpayers eligible to claim a 143.081.3(2) credit when Tax Entity ships products to another state that does have an income tax, but the state does not tax Tax Entity's income due to PL 86-272 protections?

RESPONSE 2 :

Yes, the Taxpayers are eligible for the credit under these circumstances. Based on the letter ruling request's assertion, the Tax Entity and the Taxpayers are protected under PL 86-272 from income taxes on Tax Entity's income in the other states referred to by this issue. PL 86-272's protections would apply to prohibit the imposition of an income tax on Tax Entity's income in the other states (or political subdivision), both at the S corporation level and after the income is passed through to the Taxpayers. This would satisfy item (c) that was mentioned earlier. Because items (a) and (b) mentioned above are also satisfied, the Taxpayers would be eligible for the 143.081.3(2) credit in this scenario as well.

This letter ruling is binding upon the Department of Revenue with respect to the Applicant for three (3) years from the date of this letter and is subject only to statutory changes by the General Assembly and to changes in the interpretation of law by the courts or administrative tribunals.  If a change occurs, the taxpayer who relies upon an outdated interpretation may be subject to additional taxes, interest and penalties, which may be imposed prospectively from the date of the change.  For this reason, the interpretation set forth above should be reviewed on a regular basis.  Please note that any change in or deviation from the facts as presented will render this ruling inapplicable.

Should additional information be needed, please contact Legal Counsel Vickie Adiele, General Counsel's Office, Post Office Box 475, Jefferson City, Missouri 65105-0475, phone (573) 751-0961.

Sincerely,

Wayne Wallingford

WW:RCB:VA:km