Don Warrant, CPA, Director and Anthony Gardner, CPA, Manager
The New York PTET May Help to Circumvent the $10,000 Federal Itemized Deduction Limitation for State and Local Taxes.
The New York State 2021-22 budget bill included a new Pass-Through Entity Tax (“PTET”) regime, which is an electable tax on pass-through entities, effective for tax years beginning on or after January 1, 2021. Eligible partnerships and S corporations with a New York filing requirement have the option to pay an entity-level tax at graduated rates.
The PTET provides certain individual taxpayers a viable workaround of the 2017 Tax Cuts and Jobs Act’s $10,000 State and Local Tax (“SALT”) itemized deduction limitation. There has been discussion in Congress on increasing the $10,000 SALT cap, but for now it remains intact. New York State became the eleventh state to enact a PTET workaround, with more surely to follow since the IRS has approved the workaround structure via guidance issued in November 2020. A PTET regime is electable in Alabama, Arkansas, Idaho, Louisiana, Maryland, New Jersey, Oklahoma, Rhode Island, Wisconsin, while Connecticut’s PTET is mandatory.
An eligible pass-through entity, such as a partnership or New York S corporation, can elect to be subject to a tax at the entity level. An eligible pass-through entity excludes publicly traded partnerships but includes limited liability companies taxed as either partnerships or S corporations. The tax paid is deductible on the eligible pass-through entity’s federal tax return and reflected as a reduction of the individual partner’s or shareholder’s income or loss reported on a Schedule K-1. To avoid double taxation, the state provides partners and shareholders of eligible electing pass-through entities a tax credit against state personal income tax for their share of the PTET, thereby circumventing the federal, state and local tax cap. The resident's share of the PTET must also be added back in determining the resident's taxable income to avoid a double benefit.
Making the PTET Election and Estimated Tax Payments
Generally, the irrevocable annual election must be made by the eligible pass-through entity by March 15 of the calendar year to which the election relates, and any such electing entity must make quarterly estimated PTET payments on March 15, June 15, September 15 and December 15 of the election year. The election is irrevocable for each tax year for which it is made. The estimated PTET payment dates appear to be the same for both fiscal year and calendar year filers. The amount of PTET paid by an electing entity, and the corresponding PTET credit (“PTETC”) to be received by a partner or shareholder, as applicable, with respect to the PTET, can then be taken into account by the partner or shareholder in calculating its New York State estimated tax payments due on April 15, June 15, and September 15 of the election year, and on January 15 of the following year.
Under a safe harbor provision, the required annual PTET payment is based on the lesser of 90% of the PTET for the taxable year for which the election is effective, or 100% of the PTET for the immediately preceding tax year.
The election may be made by the following eligible individuals:
- S corporation: any officer, manager or shareholder who is authorized to make the election.
- Other pass-through entities: any member, partner, owner, or other individual with authority to bind the entity or sign returns.
Issue for consideration: The entity’s PTET return is due by March 15th following the close of the calendar year containing the final day of the entity’s taxable year (regardless if the pass-through entity is a calendar or fiscal year taxpayer). How will the nuances of filing a fiscal year filer at March 15th be handled?
Issue for consideration: What are the conditions in which the Commissioner will grant an extension of time to file or allow an amended return to be filed?
Issue for consideration: A NY resident sole proprietor conducting a trade or business through a Schedule C, E or F should consider converting to a flow-through entity (partnership or an S corporation). The conversion to flow-through entity status enables the trade or business to qualify for the NY PTET and thus circumvents the $10,000 SALT cap since the state tax deduction would otherwise be limited if the business continues to operate as a sole proprietorship.
PTET 2021 Calendar Year Election
For the PTET election to be effective for the 2021 calendar year, the election must be made by October 15, 2021 and the PTET is due by March 15, 2022.
Issue for consideration: Partners and shareholders of electing entities must compute their 2021 estimated New York State personal income tax payments as if they will not receive any PTETC and, correspondingly, penalties for underpayment of such estimated taxes are computed as if the partner or shareholder was not entitled to a PTETC. This combination of PTET payments for 2021 by electing entities with the statutory rules for computing penalties for underpayment of individuals' estimated tax can result in an onerous and inequitable duplicative payment of New York State income taxes. Accordingly, the effect of the payments of PTET by the pass-through entity and estimated tax payments by the partners and shareholders is a double payment of New York State income taxes from the date the pass-through entity makes the PTET payment until such time as the partners or shareholders claim the PTETC.
Issue for consideration: The question of when an electing entity will be able to deduct 2021 PTET payments on its Federal income tax return will likely depend on the electing entity's method of accounting. All electing entities that use the cash receipts and disbursements method of accounting and some electing entities that use an accrual method of accounting may not be able to deduct 2021 PTET on their 2021 Federal income tax returns unless they actually pay the PTET in 2021. Accordingly, in order to obtain the benefit of the PTET in 2021, many electing entities may decide to pay their PTET by December 31, 2021 to secure the tax deduction for the 2021 tax year. This acceleration of PTET payments by an electing entity may further prolong the duration of the overpayment period discussed above.
We are awaiting guidance from New York State on whether it intends to grant estimated tax penalty waivers in the case of electing entities that do make estimated tax payments during 2021, thereby enabling partners and shareholders to compute the correct amount of their individual New York State estimated tax payments.
We are also awaiting guidance regarding how partnerships and S corporations can become electing entities for the 2021 and future calendar years, and instructions for making estimated tax payments.
New York Taxable Income and Tax Rate
The tax is imposed on the electing pass-through entity’s taxable income (“PTETI”). In the case of an electing partnership, PTETI for New York purposes is the sum of all taxable income attributable to each resident partner and New York-sourced income attributable to each nonresident individual partner. In the case of an electing S corporation, only amounts derived from or connected with New York sources, to the extent they would have been included in the taxable income of shareholders, are subject to tax.
New York is only including the income of partners and shareholders that are subject to tax under Article 22 in the calculation of PTET. Accordingly, the income of corporations or other pass-through entities in a tiered structure do not appear to be included in the PTET. Guidance is needed to clarify that only income included in the taxable income of "direct" Article 22 partners or shareholders and eligible for the PTETC is included in PTETI. PTETI may include income allocable to “indirect” owner individuals who may not be entitled to claim the PTETC.
There is joint and several liability for certain partners/members and shareholders of the PTET (i.e., partners or shareholders that own more than 50% of the interest or profits of the electing partnership, and general, managing or controlling shareholders of an electing S corporation). All partners/members and shareholders are severally liable for the PTET to the extent tax is not paid by the electing partnership or electing S corporation for their direct share of the PTET.
The tax is imposed at a graduated Article 22 tax rates as follows:
PTE TAXABLE INCOME
Not over $2 million
$2 million but not over $5 million
$137,000 plus 9.65% (over $2 million)
$5 million but not over $25 million
$426,500 plus 10.30% (over $5 million)
Over $25 million
$2,486,500 plus 10.90% (over $25 million)
Issue for consideration: Certain Article 22 taxpayers may be allocated taxable income while other Article 22 taxpayers may be allocated a tax loss. How are losses treated when computing PTETI?
Issue for consideration: How does the PTET regime treat losses that may be limited such as capital losses in excess of capital gains or losses that are limited by IRC Section 469 (passive activity losses)?
Issue for consideration: Should an electing entity consider depreciation deductions and items of gain or loss arising by reason of an adjustment, under IRC Section 743(b), with respect to a transferee partner when computing PTETI?
New York State Resident Credit
A New York State resident individual is allowed a credit against any tax due, equal to their share of any PTET imposed by other states and jurisdictions, so long as it is substantially similar to the PTET imposed by New York State and such state also imposes an individual income tax.
Many states have enacted a tax similar to the PTET, but there may be some differences in how they are applied. For example, in Connecticut, the PTET is mandatory and corporate or tiered partner types may be included. In other states, a non-resident may not be required to file a state return if the income is included in a state PTET return. Additional guidance is needed to clarify when a New York State resident credit is allowed.
New York State resident individuals are not likely to receive a credit for taxes paid to other states with an entity-level tax but no personal income tax such as Texas and Tennessee.
A New York State resident individual should be allowed to claim the PTETC from other substantially similar states against their New York State income tax liability regardless of whether the New York State PTET election was made.
Other Items to Consider
- Whether guaranteed payments are included in PTETI.
- Whether retirement payments to nonresident partners that are protected from nonresident state taxation by 4 U.S.C. Section 114 are included in PTETI.
- Whether an electing entity that makes estimated PTET payments with respect to its nonresident partners is additionally required to make estimated withholding tax payments for such partners under Tax Law Section 658(c)(4).
- Whether the PTETC can be claimed on a composite return.
- The treatment of electing entities that pay taxes similar to the PTET to another jurisdiction.
- Do all pass-through entities qualify?
- Sole proprietorships should consider converting to a partnership or S-corporation to qualify for the PTET election.
- Must all owners agree to elect into the PTET?
- What is the tax impact on owners who don’t qualify for the PTETC?
- How is the taxable base calculated? Are different income sourcing rules applicable to partnerships and S corporations?
- Impact of the election on corporate and foreign partners.
- Treatment of net operating losses at the entity level.
- Impact of IRC Section 754 elections and specially allocated depreciation.
- Whether the PTETC provides a tax benefit in the state of residency for New York State nonresident individuals.
- Any ASC 740 concerns
- Whether corporate documents and partnership agreements require amendment.
- Whether the PTETC will result in an overall tax benefit or tax cost.
- Whether tax credits and tax attributes applicable at the taxpayer level are taken into account when computing PTETI at the entity level.
We addressed several of these items regarding the New York State PTET regime, but additional guidance is needed.
Conclusion and Further Guidance
The New York PTET may help to circumvent the $10,000 federal itemized deduction limitation for state and local taxes. Eligible pass-through entities contemplating this election for the 2021 calendar year should begin planning to determine whether the election may provide an overall tax benefit or tax cost. We are hopeful that New York will issue guidance soon, in advance of the October 15, 2021 deadline, or extend this deadline for the 2021 calendar year.
Should you have any questions, concerns or comments about PTET election, or wish to review your situation, please contact Anthony Gardner, in our tax services department at Anthony.email@example.com.