Calendar year 2021 has continued the trend of pass-through entity (PTE) tax proposals. With the fast approaching state tax compliance deadlines, PTEs and their owners are intensifying their attention on these taxes. PTEs and their owners should take these taxes into account when determining the impacts at the entity and owner levels. In addition, understanding relevant fact patterns is necessary when analyzing potential accounting for income tax considerations.
As background, starting with Connecticut in 2018, a number of states have enacted PTE taxes as a ‘workaround’ for the $10,000 individual state and local tax itemized deduction limitation set by the Tax Cuts and Jobs Act of 2017 for owners of PTEs. While initially there was some question about whether or not PTE tax paid would be allowed as a deduction in computing an entity’s non-separately stated taxable income, some of those concerns were resolved by IRS Notice 2020-75.
Notice 2020-75 informed taxpayers of forthcoming proposed regulations designed to clarify that state and local income taxes imposed on, and paid by, a partnership or an S corporation on its income are allowed as deductions in computing the entity’s non-separately stated income or loss for the tax year of payment. Under the regulations, partnerships and S corps would be able to deduct state and local income taxes against ordinary income, with no addback required at the individual partner or shareholder level.
As of March 2021, nine states have enacted PTE taxes, with additional states having proposed legislation this year, including California and New York. Many of these PTE tax regimes are elective, as opposed to mandatory.
Action item: The specific PTE tiered structure and resident and non-resident owner-types will drive the state tax issues that must be analyzed for purposes of considering opting into the various elective state PTE tax regimes. Some key considerations include:
For additional information about this topic, please refer to the following resources:
Guide on accounting for income taxes (partially updated May 2020)
More states considering passthrough entity taxes (February 2021)
California Senate bill proposes pass-through entity tax (January 2021)
Connecticut issues Pass-Through Entity Tax guidance; questions remain (September 2018)
New Jersey adopts optional pass-through entity tax (January 2020)
Private Company Services Tax Leader, PwC US