Composite taxes are a tasty treat; maybe not as tasty as composite butters like a honey butter or herb butter, but composite taxes are great for a person with a delicate palate such as me.  Composite taxes are a way for a business to pay the tax on behalf of a shareholder so the shareholder does not have to file a return in a non-resident state.

If a pass-through business is filing returns in 20 states across the county, that individual shareholder will likely need to file in those 20 states based on their non-resident shareholder laws.  Filing an extra 20 state returns isn’t particularly fun for the accountant or the taxpayer or even the 20 states.  The business is already filing a return in those 20 states so it’s convenient to include a composite return.  A composite return takes the allocated income for that state and applies the individual tax rate and then the company pays the tax.  The company records the payment as a distribution because the payment is made on behalf of the shareholders.  The shareholder gets their K-1 showing the income to the various states, but it also shows that the composite tax was already paid.  Thus the shareholder is no longer required to file an individual return in those 20 nonresident states, and they can still claim a credit for tax paid to another state on their home state return.

There are a few specifics to keep in mind with composite taxes.  If you have more than one source of income from a state you generally cannot file composite, it only works if you have a single source of income from that non-resident state.  Not every state has composite taxes, but most do.  A few states don’t even require the company to make estimated tax payments towards the composite tax (ND comes to mind), although some states do require estimates to be made.

Composite taxes don’t save you any money, but what they do save is time and hassle.  For pass-through entities that file in multiple states, the composite tax is helping you smear around that tax liability between the various states in a more hassle-free way while getting a credit on your home state return.  Something that doesn’t increase your overall tax burden, but saves you and me time?  That’s a tasty treat indeed!