In 2021, state legislatures have accelerated their consideration of new pass-through entity (PTE) level tax regimes. The November 2020 release of IRS Notice 2020-75 (see our previous Insight) may be partially spurring the recent state legislative activity. Notice 2020-75 validated the position that a PTE-level state tax deduction passed on to PTE members would not be limited by the $10,000 individual state and local itemized deduction limit set by the 2017 federal tax reform. Based on the IRS guidance, certain PTE owners may see significant benefits from the implementation of state PTE tax regimes.
When analyzing the impact of these PTE taxing regimes, most of which are elective, taxpayers should be prudent in their modeling as each PTE’s facts and circumstances can impact the ability of their owners to benefit from the federal individual income tax deduction of these taxes. Additionally, taxpayers will need to consider the unique mechanics of each state taxing regime when modeling out potential benefits to the owners.
State PTE proposals have gained traction after the issuance of Notice 2020-75 by the IRS. Under the right circumstances, these PTE regimes may provide significant benefits to members who otherwise are subject to the individual $10,000 state and local tax itemized deduction limit for federal income tax purposes. PTEs considering opting into such tax regimes, however, will want to model the potential tax implications for all of their investors. Partner-specific circumstances, including entity type and state of residency, may create different tax priorities for members of the same PTE
Additionally, taxpayers will want to study the mechanical requirements of such PTE tax elections, including their due dates and potential estimated payment requirements, as part of their modeling exercises to address any unexpected costs or subsequent issues. Flexible modeling may also be needed to discuss outcomes with taxpayers in different circumstances in seeking to avoid conflicts later in the process and to quickly adapt as new state proposals are put forward.