MTC Partnership Update

Last year, I wrote about the Multistate Tax Commission’s (“MTC”) undertaking called the Project on State Taxation of Partnerships (“Project”).[1] Throughout the Project, the MTC has updated the Project website with summaries, notes, markups to draft documents, and other useful information.[2] The most recent Project meeting was held on July 25, 2022.[3]

Broadly speaking, the MTC identified four primary issues for the Project to address: (1) operating income of partnerships; (2) sales of partnership interests; (3) administrative and other issues; and (4) partnership level taxes. These issues are identified in the recommendations prepared by a Standing Subcommittee of the MTC[4] and are more completely discussed in an MTC staff memorandum.[5] Throughout the Project, the MTC has maintained a working copy of an “Issue Outline” which provides an expanded discussion of issues and legal considerations relevant to the Project, most recently having been updated on October 18, 2021.[6] For those interested in the topics addressed by the MTC, all of these items are recommended reading.

At the Project meeting held on November 9, 2021, MTC staff proposed that the Project start addressing the identified issues by preparing a white paper on investment partnerships and training materials on the basics of partnership taxation.

State Taxation of Investment Partnerships

The MTC started dealing with investment partnerships by preparation of a white paper, which was most recently updated on May 20, 2022.[7] Although any number of issues may have been prioritized in the Project, perhaps the MTC started with investment partnerships (in addition to general partnership tax deduction) because MTC research indicated that 70% of all partnership income comes from the “Finance and Holding Company” industry group, the next highest category being professional services generating almost 11% of all partnership income.[8]

In describing investment partnerships, the MTC outlines three types of investment partnerships that fall in the category: (1) private equity funds; (2) hedge funds; and (3) closely held partnerships (including family entities).[9] Beyond addressing the substantial share of investment income passing through partnerships and the types of partnerships that largely make up investment partnerships, the white paper discusses a number of topics, including:

  • The state partnership tax system including federal conformity, sourcing rules, and enforcement.
  • Description of the investment partnership industry.
  • A summary of issues addressed by states as well as a survey of the various states with specific rules relating to investment partnerships.
  • An analysis of issues related to sourcing of investment partnership income.
  • A set of findings and recommendations.

Subject to certain limitations the MTC believes are needed to prevent abuse, the conclusion is that investment partnerships should not be subject to the same state income tax rules as operating partnerships. Among other reasons, this is to allow for simplified reporting of income, to treat partnership investment income consistent with other investment income, and to provide uniformity among states.[10] With that backdrop, the MTC provided a set of findings and recommendations at the end of its white paper. Although I will not restate those findings and recommendations here, they generally recommend that:

  • There should be a special sourcing rule for investment partnerships (except with respect to corporate partners);
  • States should be explicit in the rules that apply (whatever those rules may be, including the conscious decision not to adopt a special rule) to avoid uncertainty;
  • Partners who actively manage partnership investments should be excluded from the rules; and
  • The rules should not apply to partnerships invested in non-investment partnerships.

In addition to the white paper, the MTC has prepared a model statute which has actively been revised during Project meetings, the most recent of which was produced as of July 25, 2022.[11] The model statute is broken down into four sections:

  • Section 1: Purpose
  • Section 2: Definitions
  • Section 3: Certain Investment Partnership Income of Nonresident Qualified Investment Partnership Partners Excluded from Personal Income Tax
  • Section 4: Authority to Delegate (anti-abuse rule)

As stated in Section 1, the purpose of the statute is not to create an analysis where taxpayers are either (1) an investment partnership subject to the special rules or (2) a non-investment partnership subject to apportionment. Rather, the intent of the statute is merely to create a safe harbor to identify investment partnerships where partnership income should be sourced to the residency of the partners rather than apportioned. There may be partnerships not meeting the requirements of this statute which would receive the same treatment, albeit under general principals rather than the proposed safe harbor. In a preamble to the model statute, the MTC states:

This draft model is designed to impose three independent qualifications for the safe-harbor sourcing. First, the partnership must be a Qualified Investment Partnership. Second, the partner must be a Qualified Investment Partner. Third, the income or loss subject to the sourcing rules must be a Qualified Investment Partnership Income (Loss). Each of these terms is defined and imposes distinct requirements. If the partnership, or the partner, or the income does not qualify, then the income is not sourced to residence under this safe-harbor rule. Again, it may still be sourced to residence under other rules or general state sourcing principles. But to determine if the income would be sourced to residence it has to come from a Qualified Investment Partnership, must flow to a Qualified Investment Partner, and must be Qualified Investment Partnership Income. (emphasis added)

The language of the statute sets forth these three qualifications. In doing so, some of the important definitions under the proposed statute are:

  • “Qualified Investment Partnership” means a partnership that meets all the following requirements for the applicable tax period:

(A) No less than 90 percent of the cost of the partnership’s total assets consists of Qualified Investments and the office facilities and tangible personal property reasonably necessary to carry on its activities as an investment partnership;

(B) No less than 90 percent of the partnership’s Amount of Gross Income or Proceeds is derived from items that would be characterized as giving rise to Qualified Investment Partnership Income (Loss), as determined at the level of the partnership which first recognizes the items;

(C) The partnership is not a Dealer in Qualifying Investments at any time during the tax period;

(D) The partnership is not a financial institution as defined in [reference to state law]; and

(E) The partnership has certified to the [state revenue agency] that it meets the criteria above with respect to the tax period covered by the certification, in a form and at the time prescribed by the [state revenue agency].

  • “Qualified Investment Partnership Income (Loss)” means interest, dividends, distributions, or gains and losses from Qualified Investments, including distributive share from lower-tier Qualified Investment Partnerships. For purposes of this definition, distributive share of items from lower-tier Qualified Investment Partnerships retain their characterization as either items as Qualified Investment Partnership Income (Loss), or not, as the items pass through any upper tier partnerships.

Although there are other important definitions in the proposed statute, seeing these proposed definitions should provide a glimpse into the limitations of what the statute seeks to capture. With that established, Section 3 provides that a non-resident partner is exempt from tax in the partnership’s state. Rather, the partner is subject to tax based on the partner’s residency. An exception to this exclusion applies (i.e. the benefit of safe harbor investment partnership treatment is lost):

[…] to the extent derived directly or indirectly from an investment in an entity if the Nonresident QIP Partner holds or has held within the last five years a direct ownership interest in that entity, unless the entity is a publicly traded entity or the Nonresident QIP Partner does not or did not actively participate in the entity’s activities. For this purpose, active participation means being an officer or director, or holding an ownership interest greater than 20%.

From there, Section 4 provides a very broad anti-abuse rule. In addition to other language, Section 4 allows states to revoke applicability if the state “determines that this Act has been used to avoid [state] income tax liability.” The model does not contain any limitation on the anti-abuse powers such as standards which apply or the revenue department’s right to make adjustment. From the model, it appears that the intention of the MTC is to leave these items to the states in adopting the statute or drafting regulations.


State tax of partnerships is often unclear and widely varied among the states. To that end, I applaud the MTC for their efforts. Investment partnership rules are the first substantive work of the Project. We will see how this continues to develop and what comes next.

The model statute is not without criticism.[12] Some of those criticisms are aimed at the restrictions on applicability of the statute. According to the MTC, states limit the applicably of special rules for investment partnerships because:

[…] an important reason for the limitations imposed by states on the special sourcing treatment is the need to avoid the shifting of income sourcing through the use of an investment partnership structure. If it were simple to change the general sourcing of partnership income by simply inserting a tiered partnership above a business partnership, and to qualify that tiered partner as an investment partnership, then state sourcing requirements would become elective.

This is similar language used in the MTC’s amicus brief[13] to the U.S. Supreme Court in the Noell Industries[14] case. In that brief, the MTC stated “the mere formality of creating a holding company can be used to undermine state tax jurisdiction in a way that raises a substantial threat to existing state tax systems” and “the expense and difficulty of creating a holding company is minimal. It can easily be incorporated in any state. And, while we acknowledge there are legitimate reasons for creating holding companies, avoiding state income taxes should not be one of them.” Although Noell Industries involved the sale of partnership interests by a holding company partnership rather than passthrough operating income of an investment partnership (which is the Project’s current subject matter), this clearly is a theme the MTC is focusing upon.

When these limitations are combined with broad anti-abuse provisions, the work of the MTC seems to be hindered by extreme attention placed on the possibility of taxpayers seeking tax avoidance. That is a concern. However, if the scope of work the Project generates is too narrow, much good that could be gained from certainty and uniformity will be lost. With respect to the sale of partnership interests, I previously said I hope “the Project is not a device by the MTC to reach a foregone conclusion – that states may tax the sale of partnership interests by non-resident partners if the partnership generated apportionable operating income in the state.” The same concept can apply to the Project’s work on investment partnerships. I hope the MTC is not using the Project to achieve some preconceived agenda to thwart taxpayers. Rather, helping taxpayers with clarity and uniformity does good to taxpayers and states. That hopefully is the genuine priority. The MTC is giving the ABA and AICPA time to comment before proceeding. It will be interesting to see what comments are received.

[1] Edmondson, Gray, “MTC Project on State Taxation of Partnerships,” Sept. 13, 2021,


[3] Project meetings are open to the public and can be accessed via log-in/dial-in information on the Project website.





[8] Id. at pg. 34.

[9] Id. at pg. 32.

[10] See MTC staff recommendations,


[12] See, e.g., comments submitted by Bruce P. Ely dated July 6, 2022.


[14] Noell Industries, Inc. v. Idaho State Tax Commission, 470 P.3d 1176 (Idaho 2020).


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