T-Bill Investment Strategy

[Snaggletooth]

Just did a return for 100% shareholder of sub-S corporation. Corporation operates 80% in Alabama and 20% in four other states, so I was treated to K-1s from Federal and five states.

Shareholder's tax liability to the various states exceeded $90,000 collectively.

K-1 Interest income, a separately stated item, was $68,000. Turns out almost all of this interest was earned by $2 million investment in U S Treasury notes.

Had the shareholder owned this $2MM in T-bills, the interest would have been tax-free in all of the states. I'm thinking the pass-through from the corporation should have been tax exempt as well (for state purposes).

However, I don't see the provision for any pass-through of state exempt interest, and in general, shareholders would not necessarily know the interest was coming from T-bills. And I don't think there is a need for such a category on the Federal K-1.

Any comments or ideas as to how to deal with this? (For those of you not totally brain-dead from the April 15th virus)

[joanmcq]

Some of the states like CA have their own K-1s. I've gotten ones for NY residents where NY adjustments were calculated based on muni income that was not taxable for federal, but was for NY, because it wasn't NY muni. The statements also gave foreign income for computation of the foreign tax credit and such. If the preparer of the K-1s had any smarts there would be at least a page with adjustments and other underlying info for the shareholder. Do the states have adjustment pages for K-1 differences?

I'm not brain dead, because I'm essentially done, and actually got to relax last night and my mental alarm did not go off this morning (which will wake me up around 6am no matter when I went to sleep if anything is pressing), allowing me to sleep in for the first time in weeks.

[Snaggletooth]

Multi-State Compact

Hi Joan, thanks for responding. Congratulations for getting done with your work a day or two before the deadline. I did the same. Of course, I never know when the phone may ring.

As far as I know, all states(43) who have income taxes have their own version of the K-1. And many of these states are signators to the "multistate tax compact" which creates a different format and disallows credit for taxes paid to other states. Alabama is signatory, and I don't really know how many states have agreed or not agreed.

The compact format calls for a proration of the federal income by state. For example, if 80% of the operation is in Alabama, and Federal K-1 is for $1,000,000, then an "Alabama K-1" is issued for $800,000 instead of the entire $1000000. The taxpayer is only taxed on $800K for Alabama purposes, but is NOT allowed a credit for taxes paid to another state.

Had Alabama not agreed to the compact, the Alabama K-1 would be for the entire $1MM,
and taxed accordingly. Then the taxpayer would take credit for "taxes paid to another state" on his personal return.

Thank you for your response. I think of my cousin in Vacaville every time I read one of your posts. He is a professor of European History at Cal-Davis. (How's that for off-topic)

[veritas]

Snag

In my software there is a a distinction between bank interest and interest from US obligations. I doubt very much whether any state can tax interest from a Treasury note.

The US Constitution prevents states from taxing interest from obligations used by the federal government to operate.

[Snaggletooth]

[QUOTE=veritas;59139]In my software there is a distinction between bank interest and interest from US obligations.QUOTE]

Yes, this is the case in all software I've seen. However, the distinction doesn't not carry through to interest passed through from a K-1. That is the very crux of the problem.

[JG EA]

Look for a line on the states for US Gov Obligations. Or if you can't find that you can always put it in as a K-1 subtraction.