Multi-state K-1 earnings to S-Corp

Question

I am sole shareholder in a State #1 S-Corp. I funnel various earned income (I have various business interests) into this S-Corp from which I pay myself a salary, pay business expenses and profit distributions.

The S-Corp is a minority partner in a State #2 LLC and receives a K-1 each year. The LLC is profitable and pays a regular distribution of profit to the S-Corp. The LLC pays, as required, PTE taxes to State #2 on my behalf.

My current CPA is filing a State #1 filing declaring the S-Corp income upon which I pay taxes on the profits. In State #2, I file for a refund of the PTE less a small amount undistributed income held by the LLC at year end. I pay State #2 a taxes on this undistributed income and claim credit with State #1)

One of the other LLC partners is paid as a normal individual (meaning they don't have their own S-Corp) however they also reside in State #1. State #2 has audited them and declared that they owe taxes on this K-1 income. The partner, is now having to get refunds from State #1 for taxes paid and remit this along with hefty fines to State #2.

My concern is whether State #2, despite me having an S-Corp, could determine the S-Corp K-1 income is taxable in State #2.

Answer 1

I'm not sure why you think that it matters that the distribution goes to an S-Corp vs an individual tax payer. You seem to think it has any relevance to your question, but it doesn't. It only confuses your readers.

The situation is like this:

LLC X is deriving income in State #2. It has two members (I and S) residents of State #1.

Members I and S pay all their taxes to State #1, and don't pay taxes to State #2. State #2 audited member I and that member now needs to pay back taxes and penalties to State #2 on income derived from that State.

Your question:

Does that mean that member S should be worried, since that member was essentially doing the exact same thing as member I?

My answer:

Yes.