A major component of the Tax Cuts and Jobs Act of 2017 is the $10,000 annual limit on state and local taxes included in an individual’s itemized deductions. This limitation applies to tax years 2018 through 2025. As a workaround, states have enacted elective pass-through entity-level taxes (PTET) to allow individuals to obtain a benefit for the state taxes paid on their income. These PTET elections allow the states to impose income tax directly on the pass-through entities rather than the individual owners. The guidance provided in IRS Notice 2020-75 allows the pass-through entity to include these elective tax payments as a deduction in determining non-separately stated income or loss.
The exact implementation of the PTET elections varies significantly by state. The general process is as follows. The pass-through entity makes the election. On that entity’s state tax return, it pays tax on any state income. This tax payment is included as a deduction on the pass-through entity’s federal tax return and reduces non-separately stated income or loss. On the owners’ individual federal returns, this payment has already been included in their income from the pass-through entity and is not separately reported. On the owners’ state returns, the state may allow a credit for an owner’s share of taxes paid by the pass-through entity. Alternatively, the state may require a reduction in state-taxable income for income already taxed on the pass-through entity’s return.
It is important to note that the PTET elections are designed to provide a federal benefit to individual owners. The total amount of state tax paid by the owners may increase or decrease as a result of making PTET elections, depending on the specific facts. The scenario which will most likely provide a net benefit to the owners is when the pass-through entity has a large portion of its taxable income in a state with a PTET election and the owners’ resident state allows a credit for taxes paid to other states on payments made by the entity.
As of September 1, 2022, 29 states and one city have enacted PTET elections.
States with elections available for tax year 2021
States (and one city) with elections available starting tax year 2022
The deadline to make a 2022 election has passed for California, New York, and New York City. California requires an estimated tax payment remitted by June 15. New York requires a separate election by March 15 of the year to which it applies. That deadline was extended to September 15 for 2022. For 2022 only, New York City requires that the New York State election be made.
Virginia has indicated it will publish guidance on making a retroactive election for 2021 prior to October 15, 2023. Colorado will allow retroactive elections back to 2018 through filing amended composite returns between September 1, 2023 and July 1, 2024.
The eligibility to make and the impact of making PTET elections is dependent on the details of the pass-through entity and its owners.
Some important considerations:
- Do the owners’ resident states allow a credit for taxes paid to other states on PTET payments made by the entity? The loss of this resident state credit may negate any expected benefit from the reduction in federal income.
- The PTET tax rate may be greater than the rate imposed on the individual owners.
- Certain credits and deductions available to individual owners may not be allowed in computing the PTET.
- Do the owners still need to file a return with the state? If so, how do they account for the PTET?
- What is the method and timing for making the election? This may be a checkbox on the pass-through entity’s annual return, or a separate application may be required. The election is generally due prior to the original due date of the pass-through entity’s return.
- Most states require an annual election. A few states apply the election to subsequent years until it is revoked.
- Once made, is a state's election irrevocable for the year?
- Are all owner types eligible to be included in the PTET calculations? Will certain owners prevent an entity from making an election?
For more information on how PTET may impact your filing, reach out to a tax professional at FORVIS or submit the Contact Us form below.
View more articles from Year End Tax Planning: FORVIS’ 2022 Tax Guide here.