Type of entity determines treatment of nonresident owners of N.C. investment activities.

The North Carolina Department of Revenue has ruled that a partnership whose only activities within the state are in the nature of an investment account (in which securities are held for capital appreciation and income, dividends and interest are received, and stocks and bonds occasionally sold) will not be deemed to carry on a trade or business in North Carolina. Consequently, the partnership's nonresident partners do not have North Carolina taxable income. To obtain this treatment, the partnership's activity should not rise to the level of a trade or business through maintaining an office and employees in North Carolina or through frequent turning of the investments.

An S corporation engaged in the same activity as the partnership described above receives very different treatment. S corporations are subject to the same allocation and apportionment rules as C corporations. If the interest, dividends and capital gains are considered nonbusiness income, they are directly allocated to the state of commercial domicile (i.e., the principal place from which the business is directed or managed). If the commercial domicile is North Carolina, the investment income will be North Carolina taxable income to the nonresident shareholders. This is a disadvantage if the North Carolina tax rate is higher than the rate in the state in which the shareholder resides.

If an investment activity with nonresident owners is to be directed from North Carolina, the income will receive more favorable tax treatment in a partnership or limited liability company taxed as a partnership than in an S corporation. If an S corporation is engaged in similar activity, the investments should be managed from a location outside North Carolina in a state that provides more favorable treatment to nonresident owners.