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New York enacts a Pass-Through Entity Level Tax

New York enacts a Pass-Through Entity Level Tax
New York is the latest state to establish a workaround to the federal SALT deduction limit

Now that the 2020 tax filing season is, for the most part, behind us, it is time to start thinking about 2021 tax matters, including state and local income tax changes for 2021.

A look ahead reveals more states entering the entity-level tax mix for 2021. In recent years, entity-level taxes for passthrough entities (PTE), partnership and S corporations, started popping up across the country in an effort to minimize the impact of the $10,000 state and local tax (SALT) cap, which was included in the Tax Cut and Job Act (TCJA) of 2017.

There had been speculation that the Internal Revenue Service (IRS) might allow the deduction of state-imposed entity level taxes by PTE, thereby decreasing the income passing to the owners. Some expected that the IRS would start cracking down on states’ “workarounds.” Connecticut, Maryland, New Jersey and Wisconsin did not wait for IRS guidance and forged ahead with entity-level taxes on PTEs.

New York is the latest state to enact a SALT “workaround” tax
The FY 2022 budget for New York State (NYS) included a new Pass-Through Entity Tax (“PTET”), which goes into effective January 1, 2021.

For 2021 the annual NY PTET election can be made by 10/15/2021 and is normally due by the due date of the first quarterly estimated payment.

NYS’s PTET is an annual electable entity level tax. The election is irrevocable and is made by the due date of the first quarterly estimated payment (March 15) of each year; however, the 2021 election can be made through October 15, 2021. Electing PTEs cannot amend without Commissioner approval. Quarterly estimated payments are required at 90% of current year’s actual tax or 100% of prior year’s tax. Required estimated payments are waived for 2021.

Rules for computing the PTET election tax and the applicable taxable income
The PTET election tax is computed on the taxable income with respect to the distributive share of direct “NYS Article 22” owners, which are those subject to NYS personal income tax. PTEs with disregarded entity owners must provide enough information to identify both the disregarded entity that is the owner and the taxpayer subject to tax under Article 22. PTEs with entity partners (i.e. corporations or partnerships) are not disqualified from making the election, but the PTET would only be computed on the distributive share of its Article 22 owners.

Computing the taxable income may be a little tricky. The taxable income for resident partners of partnerships would include all income, while the taxable income for nonresident partners and S corporation shareholders (resident and non-resident) would be limited to the New York source income. In addition, the legislation suggests that the allocation for partnerships would calculate New York source income using cost of performance rules and S corporations would calculate using market-based rules. Graduated tax rates range from 6.85% on the first $2 million up to 10.9% on taxable income in excess of $25 million. The shareholders, partners and members are jointly and severally liable for unpaid NYS PTE taxes owed by electing PTEs.

Electing PTEs will pass the proportionate share of the NYS PTET to its partners, members or shareholders to be claimed as a personal income tax credit. Any excess credit over the amount of tax due will be refunded or credited.

Case by case analysis is needed before making the NY PTET election
This sounds like a no-brainer, but don’t be too eager to file the election. As more states add entity level taxes in response to the $10,000 SALT cap, they seem to be falling into two general groups. One is states like Louisiana, Oklahoma, and Wisconsin that compute the tax at the entity level, similar to a C corporation, leaving no income or credit to pass-through to the owners. While other states, like Connecticut, Maryland, New Jersey, Rhode Island, and New York compute the tax at the entity level, then pass the income to the owners, along with a credit. Generally, taxpayers receive a credit on the portion of their income taxed in other states. How does this work for those states computing the entity level tax and not passing the income to the owners, like Louisiana, or Wisconsin? There’s no question that the income was taxed, but can a credit be claimed if the income did not flow through to the owners?

The PTE owners’ resident states should be determined and each states’ interpretation of “credit for taxes paid to other states” must be considered. A higher SALT bill may not necessarily mean a higher overall tax bill when the reduction in pass-through income for federal income tax is considered and vice versa. There is no one-size-fits-all and every PTE and its owners should work with a knowledgeable tax professional to ensure the best overall tax savings for the group.

Please contact your Herbein tax consultant if you have questions regarding this article or need assistance analyzing your state and local tax situation. Article prepared by Jeanettee Hassis.