Do a lower-tier partnership's apportionment factors flow up to its partners?

The structure, and why the classification comes first

The illustration is an operating partnership, a Delaware LLC taxed as a partnership, that holds an investment management group's assets. The REIT partner holds about 90 percent of it, the management corporation (a C corporation) about 5 percent, and the executive partnership, an upper-tier partnership through which senior executives invest, the rest. Below the operating partnership sit lower-tier LLCs and LPs that own real estate in several states, hold loans secured by real estate, and hold interests in investment funds that own real estate and operating businesses. The operating partnership has receipts of about $400 million from rents, interest, fund distributions and management-related income, files partnership returns in about 30 states, and withholds or pays composite tax for its partners where required.

In that structure the operating partnership is the upper tier to its own investments and a lower tier to the executive partnership; to the REIT partner and the management corporation it is the partnership whose factors may or may not reach their returns. The same question arises at every link: does the state in question combine the lower tier's factors with the upper tier's own, have the lower tier apportion and pass up a state-sourced amount, or tax the lower tier itself? The answer is not one answer for the structure. A single lower-tier LP can flow up its receipts factor to the REIT partner in one state, pass up a sourced amount in a second, and pay its own tax in a third. The answer also differs by partner type within one state, because several states apply one rule to corporate partners and another to individuals.

The practical stakes are data: an aggregating partner needs dollar factors from every lower tier, a separate-entity state needs a state-sourced amount on the K-1, and an entity-level state needs to know which lower tiers filed and paid. A workpaper built for one approach does not serve the others.

Aggregate states, and whether unity is required

California, corporate partners. California's partnership regulation sorts on the unitary question. If the partnership's activities and the corporate partner's activities form a unitary business, determined "disregarding ownership requirements," the partner's share of the partnership's business income is combined with its own and apportioned with a formula that includes its share of the partnership's property, payroll and sales, with intercompany items eliminated (Cal. Code Regs., tit. 18, section 25137-1(a), (f)). The partner's interest is measured by its share of profits (section 25137-1(f)). If the activities are not unitary, the partnership's business is treated as a separate trade or business of the partner, its income is apportioned by the partnership's own factors under the applicable formula, and the partner reports the result (section 25137-1(g)). The regulation reaches tiers in one sentence: "The same principle applies when a taxpayer has an interest in a partnership that itself owns an interest, directly or indirectly, in one or more other partnerships" (section 25137-1(a)). It does not say whether unity is tested between the corporate partner and each lower tier, or between adjacent tiers; reading "the same principle" to require a unitary relationship with each lower tier whose factors are combined is the natural reading, but it is an inference the text does not make.

Applied to the fact pattern, the REIT partner and the management corporation each answer the unitary question against the operating partnership and, through it, each lower tier. If the REIT partner is unitary with the operating partnership, it adds 90 percent of the operating partnership's California and everywhere property, payroll and sales to its own; $360 million of receipts enter the denominator of its receipts factor. If a lower-tier fund interest is a passive holding with no integration, the operating partnership's share of that fund's income is apportioned on the fund's own factors and arrives at the REIT partner as a separate business amount. The library's article on corporate limited partners in investment funds works through the unitary test for a single fund interest; in a tiered structure the test is run link by link.

California, individual partners. For nonresident individuals the partnership apportions its business income at the partnership level, and each partner's share of the California-apportioned amount is California-source income (Cal. Code Regs., tit. 18, section 17951-4(d)(1), (d)(2)). The regulation presumes separation: "the business activity of a partnership will not ordinarily be considered part of a unitary business" with the partner's other activities (section 17951-4(d)(5)). The exception is a partner holding 20 percent or more of the partnership's capital or profits, who combines unitary business income from such interests, and "the partner shall aggregate its payroll, property and sales" into one percentage (section 17951-4(d)(6)(A)). Interests held through entities are attributed proportionately to their owners, with family attribution for individuals (section 17951-4(d)(6)(B)). An executive who holds a fraction of the operating partnership through the executive partnership does not approach 20 percent by attribution, so the general rule governs: that executive's share of the operating partnership's California-apportioned income is California-source, computed on the partnership's factors, not the executive's.

New York, corporate partners. New York's Article 9-A corporate partner rule does not turn on unity. The Department's instructions to Form IT-204-CP state that "[a] corporate partner receiving a complete Form IT-204-CP must file using the aggregate method," and that a partner is presumed to have the access to information that requires the aggregate method if any one of several conditions is met: it conducts a unitary business with the partnership; it is a general partner or an LLC's managing member; it holds a 5 percent or greater interest; it has previously reported on the aggregate method; the interest is more than 50 percent of its total assets; its basis in the interest exceeds $5 million; or a member of its affiliated group has the information (Form IT-204-CP instructions (2025)). Only a partner that meets none of those conditions, lacks access to the information and certifies those facts may use the entity method, under which "a partnership is treated as a separate entity" and the partner's interest is treated as business capital. Under the aggregate method the partner includes its distributive share of the partnership's receipts within and outside New York in its own apportionment. In the fact pattern, both the REIT partner (about 90 percent) and the management corporation (5 percent) meet the 5 percent condition and use the aggregate method whether or not either is unitary with the operating partnership.

The instructions also carry the tiers: a partnership partner uses the lower tier's form to determine the amounts to include on an aggregate basis (Form IT-204-CP instructions (2025)). The New York answer for a corporate partner is therefore aggregation down through the structure, driven by ownership and access, with unity as one trigger among seven.

The separate-entity approach: Montana

Montana keeps tiers of pass-through entities apart. The Department's 2025 instructions to Form PTE measure the receipts factor, now the only factor, by "all gross receipts of the PTE exclusive of nonapportionable income and intercompany transactions" (Montana Form PTE Instructions (2025), Schedule I). Income from other pass-through entities reported on federal K-1s is removed from the filer's apportionable income, and the Montana-source income those entities report on their Montana K-1s is added back as Montana-source income.

The Department's guidance states the principle: "The original entity that generates income determines the state sourcing and characteristic of the income," and "Montana source income received from another pass-through entity is not included in apportionment and cannot be re-characterized" (Montana Department of Revenue, Montana Source Income). The upper tier separates the K-1 income from its own trade or business, classifies and apportions only its own activities, and then adds the lower tier's Montana-source amount. The same page notes that a partnership with a C corporation among its direct or indirect owners may be unitary with that corporation, which moves that partner's question to the corporate income tax. For periods beginning after December 31, 2024, Montana's apportionment formula uses the receipts factor alone (Montana Source Income; Form PTE Instructions (2025), What's New).

In the fact pattern, a lower-tier LP that owns Montana property computes its own Montana apportionment on its own factors and reports a Montana-source amount to the operating partnership. The operating partnership does not combine the LP's factors with its own; it reports that amount as received and passes it up, and the composite or withholding computation runs on the aggregated Montana-source items.

Entity-level states: New Hampshire, Tennessee and Texas

New Hampshire. The business profits tax treats a partnership or LLC as a "business organization," and provides that one "whose net income is reportable by the true owners either directly or indirectly" shall be "subject to tax at the entity level," and that "no part of such earnings or loss shall be included in the calculation of the gross business profits of the owners of such entity" (N.H. RSA 77-A:1, I). The Department's rules carry the same instruction to the owner: the pass-through entity includes all of its items on its own return, and those items are removed from the true owner's return (N.H. Admin. Rules, Rev 302.05). Nothing flows up.

New Hampshire reaches across tiers only through combination. "When 2 or more related business organizations are engaged in a unitary business," the state's share of income is determined "by means of the applicable combined apportionment factors" (RSA 77-A:3, III). A unitary business is "one or more related business organizations engaged in business activity both within and without this state among which there exists a unity of ownership, operation, and use; or an interdependence in their functions" (RSA 77-A:1, XIV), and the rules define unity of ownership as ownership, direct or indirect, by the same economic entity or group of economic entities, with no percentage threshold (Rev 301.35; Rev 301.07). Gross business profits are apportioned by the sales factor alone for periods ending on or after December 31, 2022 (RSA 77-A:3, I(b)). An upper tier whose only New Hampshire connection is a lower-tier LLC doing business there reports none of the LLC's earnings; if it is in a unitary business with that LLC, it is part of the combined group. How a partnership member's income and factors interact with its corporate owner's inside a combined group, given the exclusion in RSA 77-A:1, I, is not addressed in the Department's business profits tax rules and is an open question.

Tennessee. Tennessee taxes limited partnerships, LLCs and other entities that offer limited liability directly; the Department's manual describes Tennessee as unique in taxing pass-through entities directly at the entity level (Franchise and Excise Tax Manual (June 2026), Direct Taxation of Pass-Through Entities). General partnerships are not taxed at the entity level, and their activity is taxed to owners that offer limited liability.

Tennessee is a hybrid rather than a pure entity-level state, because its answer turns on whether the lower tier itself is subject to the excise tax. Where a lower-tier LP or LLC is doing business in Tennessee and files its own return, an owner that files reverses its distributive share of that entity's income, gains, expenses and losses out of its excise tax base, and the entity's sales are omitted from the owner's apportionment factors (Manual, Schedule J line 25 and Pass-through Entity Ownership, citing Tenn. Code Ann. section 67-4-2006(b)(1)(J) and (b)(2)(L)). Where the lower tier is not doing business in Tennessee, the statute flows its receipts up: gross receipts include "a taxpayer's ownership share of gross receipts of any limited partnership, subchapter S corporation, limited liability company, or other entity treated as a partnership for federal income tax purposes, in which the taxpayer has an ownership interest, directly or indirectly through one (1) or more such entities, and that is not doing business in Tennessee and thus is not subject to Tennessee excise tax" (Tenn. Code Ann. section 67-4-2012(g)). The owner's excise tax base keeps that entity's income. A general partnership's share is always included. For tax years ending on or after December 31, 2025, standard apportionment uses the sales factor alone (Manual, Standard Apportionment).

In the fact pattern, a lower-tier LP that owns Tennessee buildings is a Tennessee taxpayer and pays its own franchise and excise tax; if the operating partnership files in Tennessee for its own reasons, it reverses the LP's income and leaves the LP's sales out of its factor. A lower-tier fund LLC that is not doing business in Tennessee is the opposite case: its receipts, through every tier, enter the owner's receipts factor.

Texas. The franchise tax treats partnerships (general, limited and limited liability) as taxable entities, with an exception for general partnerships owned entirely by natural persons, and "[t]axable entities that are part of an affiliated group engaged in a unitary business must file a combined group report" (Texas Comptroller, Publication 98-806, Texas Franchise Tax (12/2023)). A lower-tier partnership doing business in Texas that is not a passive entity therefore reports and pays on its own, or as a member of a combined group. Outside combination, Texas offers an elective route upward: under Tax Code section 171.1015, a lower tier that is not part of a combined group may report total revenue to any or all of its upper-tier entities according to their ownership interests, on Form 05-175, and exclude what it reports from its own total revenue. The Comptroller's guidance adds three limits: the provision "is not available if the lower tier entity is included in a combined group," it is not an alternative to mandatory combination, and revenue cannot be reported to an upper tier that is not itself subject to the franchise tax (Texas Comptroller, Franchise Tax Frequently Asked Questions, Tiered Partnerships). The no-tax-due threshold and the E-Z computation are tested before any attribution.

The unitary question, state by state

Aggregation is often described as a unitary method, and in California it is (section 25137-1(f), (g)). New York separates the two ideas: a non-unitary corporate partner with a 5 percent interest, a basis over $5 million, or access to the information aggregates anyway. Montana leaves unity to the corporate income tax where a C corporation is an owner; New Hampshire and Texas combine only unitary groups, and Texas otherwise allows elective attribution of revenue; Tennessee does not ask the unitary question for this purpose, because its test is whether the lower tier is subject to the excise tax. Oregon requires a corporate partner to include its share of the property, payroll and sales of a partnership that is part of its overall business operations, measured by capital account plus its share of partnership debt, but the rule does not address lower tiers (Or. Admin. R. 150-314-0385(8)).

Two consequences follow. First, a single unitary position does not carry across states. A corporate partner that is unitary with the operating partnership aggregates in California and New York for different reasons, and a partner that is not unitary still aggregates in New York but not in California. Second, the unitary answer in a state that requires it is a factual determination about each link: the operating partnership may be unitary with a lower-tier LLC that manages properties and not with a fund interest it holds for return. The library's article on the unitary business principle states the constitutional test; applying it here means testing each lower tier whose factors a partner proposes to combine.

What each tier has to ask for

The classification sets the information request, and the request is better built before the lower tiers close their books than after the partners' returns are due.

1. For aggregate states, the upper tier needs each lower tier's property, payroll and receipts in dollars at 100 percent, in total and by state, with the ownership chain needed to scale them. An indirect interest is the product of the interests at each link: a 50 percent interest in an LLC that owns 40 percent of a fund is a 20 percent indirect interest in the fund's factors. A lower tier whose activity is entirely in one state still supplies the dollar amounts, because an aggregating partner combines them with its own.
2. The measure of the interest matters. California uses the share of profits (section 25137-1(f)); a state K-1 may use a beginning, ending or average percentage, and where interests change during the year the difference is computed and documented rather than assumed small.
3. For New York, the operating partnership supplies Form IT-204-CP to its corporate partners and carries lower-tier information through on an aggregate basis.
4. For Montana, the lower tier supplies its own apportionment and a Montana-source amount on its Montana K-1, and the upper tier removes the federal K-1 income from its own apportionable income.
5. For Tennessee, the upper tier needs to know which lower tiers are doing business in Tennessee and filing, because that fact decides whether each entity's income is reversed and its sales omitted, or kept and flowed into the receipts factor.
6. For Texas, the questions are combined group membership and whether any lower tier will report total revenue upward on Form 05-175.

In the year the operating partnership sells a lower-tier operating platform for a gain of about $900 million, larger than all its other receipts combined, the classification also decides where the gain's dilution lands: in an aggregate state it enters the corporate partner's combined denominator if the gain is in the receipts factor at all, while in a separate-entity state it stays inside the operating partnership's own apportionment. Whether a gain of that size belongs in the receipts factor, and at gross or net, is a separate question with its own state rules.

Practice notes

The sound sequence for a tiered structure is a map before a computation: for each filing state, for each tier and for each partner type, whether the state aggregates, separates or taxes at the entity level, and where it aggregates, whether it requires a unitary relationship. A corporate partner's unitary position is tested against each lower tier in each state that conditions aggregation on unity, documented with the facts that carry it, and not assumed to hold in states that apply a different test. Lower tiers are asked for dollar factors and ownership chains, not percentages, and Tennessee and Texas filings at the lower tiers are listed before any upper-tier return is prepared, because those filings decide what the upper tier reverses, omits or receives. A partnership that has been passing up factors on one approach everywhere is likely to find states where the opposite approach was required, and the years still open for refund are worth reviewing on the correct approach. G&G State Tax Group provides tiered partnership apportionment mapping, unitary analysis and lower-tier information protocols alongside its state and local tax practice.