(b) Example 2 - Taxpayer, a
full-year Montana resident, was a shareholder in an S corporation that was
engaged in banking in State X in 2017. State X does not allow S corporations
engaged in financial businesses to elect state-level S corporation treatment
and imposes a tax on them measured by net income. The following represents what
occurred:
(i) The S corporation was required
to and did file a 2017 income tax return with State X in 2018 and paid a tax
measured by its net income of $132,000, $121,000 by estimated payments made in
2017 and the balance of $11,000 in 2018 when it filed its 2017
return;
(ii) The S corporation paid
$15,000 tax to State X for tax year 2016 when it filed its 2016 return in 2017.
The S corporation's non-separately stated and separately stated items for tax
year 2017 were as follows, of which the Montana resident shareholder's share
was 10 percent:
(A) An ordinary income of
$2,000,000 from banking business includes a deduction of $136,000 for State X
taxes paid in 2017, $121,000 for estimated payments in 2017, and $15,000 for
2016 taxes paid in 2017;
Tax exempt interest income $1,200,000
Ordinary dividends 300,000
(B) The taxpayer's total 2017 Montana AGI was
$500,000, which included 10 percent of the S corporation's ordinary dividends,
or $30,000, and 10 percent of the ordinary income from its banking business, or
$200,000;
(C) The shareholder's
$200,000 share of the S corporation's ordinary income from its business was
reduced by the shareholder's share of the S corporation's deduction for
$136,000 income taxes paid to State X in 2017, or by $13,600 (had the
shareholder paid the shareholder's 10 percent share of the State X's taxes
rather than the S corporation, the shareholder's 10 percent pro rata share of
the S corporation's ordinary income for 2017 would have been
$213,600);
(D) The shareholder's 10
percent share of the S corporation's tax-exempt interest, or $120,000, is
exempt from Montana individual income tax but is subject to tax by State X;
and
(E) Assume the taxpayer's 2017
Montana tax liability would be $50,000 if the credit were not
claimed;
(iii) The
taxpayer calculates the Montana income tax liability and the amount of credit
the taxpayer may claim against the 2017 income tax liability as follows:
(A) The taxpayer's Montana taxable income is
increased by the pro rata share of the S corporation's deduction for State X
taxes paid for which the taxpayer claims the credit;
Montana AGI: $500,000
Reverse deduction: 13,600
Adjusted MT AGI: $513,600
(B) The taxpayer's pro rata share of the tax
reported and paid to State X by the S corporation for 2017 ($13,200) is
multiplied by the proportion of the taxpayer's pro rata share of the S
corporation income taxed in State X that is not exempt in Montana ($230,000) to
the taxpayer's pro rata share of the amount of income that is taxable in State
X, including income that is exempt in Montana ($350,000):
Ordinary income from banking operations $200,000
Ordinary dividends 30,000
S corporation income exempt from Montana tax 120,000
Taxpayer's share of income tax reported and paid to State X
on income that is not exempt in Montana:
$13,200 x $230,000 / $350,000 = $8,674
(C) The taxpayer's Montana income tax
liability is recalculated. Tax on adjusted Montana AGI of $513,600: $56,500
(assumed result). The recalculated Montana income tax liability ($56,500) is
multiplied by the ratio of S corporation net income included in Montana AGI,
increased by the pro rata share of the S corporation deduction for the income
taxes paid ($200,000 + $30,000 + $13,600 = $243,600) to the taxpayer's total
Montana AGI, increased by the pro rata share of the S corporation deduction for
income taxes paid ($513,600).
Montana income tax attributable to income that is taxed in
both states:
$56,500 x $243,600 / $513,600 = $26,798
(D) The allowable credit is $8,674, the lower
of:
(I) pro rata share of the income tax
reported and paid by the S corporation, $13,200;
(II) pro rata share of the amount of the
income tax reported and paid to the other state or foreign country by the S
corporation on their pro rata share of income that is not exempt in Montana,
$8,674; and
(III) proportionate
amount of the Montana income tax attributable to their pro rata share of income
of the S corporation reported to the other state or foreign country,
$26,798.