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Georgia’s mandatory withholding rules on distributions made to nonresident owners of Georgia pass-through entities, and the State’s current aggressive enforcement of those rules, warrant your attention. Created in 1993 to ensure collection of tax on in-state income distributed to out-of-state owners, the withholding rules essentially added a layer of entity-level reporting and collection compliance. Now new rules, effective for taxable years beginning on or after January 1, 2006, redefine distributions and affect how entities remit tax on behalf of nonresident owners.

We encourage you to call your Smith & Howard tax professional prior to taking any action.

Potential Penalties

The Georgia Department of Revenue may impose a 100% penalty for failure to comply with the withholding rules on nonresident distributions. This penalty may be imposed on the entity and/or all of the entity’s owners, both resident and nonresident.

Entities Subject To Withholding

The withholding requirements apply to any S corporation, Partnership or Limited Liability Company (treated as a Partnership or S Corporation for federal income tax purposes and required to file a Partnership or S Corporation tax return).

Distributions Redefined

Distributions include a cash payment; a payment of other property, a credit to the owner in lieu of a payment; and for tax years beginning in 2006, the owner’s share of income passed through on a Schedule K-1 (with no reduction for the Section 179 expensing election), reduced by previous distributions already subject to withholding. If the entity owns property or does business within and outside of Georgia, then rules require withholding only on the portion of the distribution attributable to Georgia business. Distributions do not include rent, royalty or compensation payments to an owner, returns of capital and deemed distributions (i.e. partnership liability shifts).

Withholding Tax

A 4-percent withholding rate applies to the distributions, which include pass-through income, made to nonresident owners. The entity remits the withheld tax to the Georgia Department of Revenue (DOR) within 30 days after the end of the calendar month in which the distribution is paid or credited to the nonresident owner. A deemed distribution of pass-through income is considered a distribution paid on the last day of the year. Withholding does not relieve the nonresident owner from filing a Georgia tax return. Conversely, the nonresident owner’s remittance of estimated tax payments or the filing of a Georgia tax return by the nonresident owner does not relieve the entity of the responsibility of the withholding requirement. The Georgia DOR will refund any excess of withheld tax over the nonresident owner’s actual Georgia tax liability once the nonresident owner files a Georgia income tax return.

Reporting Forms

Registration Application CRF-002: Every entity required to withhold on nonresident distributions must register even if the entity has already registered for payroll tax withholding.

GA V: Used to remit monthly withholding. An entity that withholds more than $10,000 per month must submit payments by Electronic Funds Transfer (EFT) and need not file a Form GA V. (Failure to use EFT, if required, may result in a 10% penalty.)

EFT-001: Registration for Electronic Funds Transfer

G-7: Used to remit the tax withheld on the owner’s share of income determined at year-end. Due date: on or before the last day of the month following the end of the quarter.

G-2-A: Reports nonresident owner’s share of annual withholding, like a Federal Form W-2. Due date: to nonresident owners – within 30 days after entity’s year-end close; to Georgia DOR - February 28 for a calendar year entity

G-1003: Transmittal form for all Forms G-2-A. Due date: February 28 for a calendar year entity

IT-CR: Georgia composite tax return. Due date: April 15 for a calendar year entity

Exceptions To The Withholding Requirements

No requirements exist to withhold tax on nonresident distributions if:

1. the aggregate annual distributions made to an owner are less than $1,000 per owner;
2. the owner is a corporation that does other business in Georgia, has filed income tax returns in Georgia for the two immediately-preceding years, is current on all taxes due and has made all the required quarterly estimated tax payments to Georgia;
3. the distributions are paid or credited to an exempt organization where the income generated from the entity’s activity is not considered unrelated business taxable income;
4. the entity is an insurance company already subject to tax on insurance premium income;
5. the entity is a resident limited partnership or similar nontaxable entity that derives income exclusively from buying, selling, dealing in, and holding securities on its own behalf and not as a broker;
6. the entity is a family limited partnership (certain other exceptions may apply);
7. compliance will cause undue hardship on the pass-through entity. (Entities request a determination by filing a written petition with the Commissioner. Inability to pay, unfamiliarity with the rules, and inadequate records are not undue hardships.); or
8. the entity files a composite return for nonresident owners.

Note: Regulations look to the direct owners of the entity in determining the applicability of the withholding requirements. For example, if Entity A is owned by nonresident Entity B, and Entity B is partially owned by a nonresident exempt organization, then Entity A would still be required to withhold on 100% of its distribution to Entity B because Entity B is the direct owner of Entity A.

Composite Returns

An entity may choose to file a composite return on behalf of its eligible nonresident owners, with the consent of the nonresident owners, as an alternative to withholding on distributions. Benefits of filing a composite return include the ability to compute tax based on each nonresident owner’s separately computed taxable income from the activity, use of a graduated tax rate schedule (for non-corporate taxpayers) and the ability to compute and deduct net operating losses with respect to each nonresident owner’s income. However, nonresident owners cannot be included in this composite return if they have any other reportable Georgia-source income in addition to the entity’s pass-through income. If a nonresident owner elects out of inclusion in the composite return, then the withholding requirement applies to that owner. If a composite return includes a nonresident owner who files a return in Georgia, then the composite return must be amended. Underpayment of estimated tax penalties may apply to the tax calculated on and remitted with a composite return, if the entity fails to remit estimated tax payments throughout the year. The due date of the composite return is the same as for a calendar-year individual.

We hope we have provided you with a good resource tool for Georgia’s mandatory withholding rules. Please consult with us regarding any questions you may have about the application of these rules to your specific situation. You may reach any Smith & Howard professional at 404-874-6244.

Smith & Howard, PC