A Closer Look at New York State’s Pass-Through Entity Tax
History of SALT Cap
The Tax Cuts and Jobs Act (TCJA) limited the amount of State and Local Tax (SALT) that could be included as a Federal itemized deduction to $10,000 for individuals. This provision severely impacted individuals from high-SALT states, including New York State (NYS), since for all practical purposes, the SALT Federal tax deduction was substantially minimized or eliminated for most individuals.
Internal Revenue Service Notice 2020-75
On November 9, 2020, the Internal Revenue Service (IRS) issued Notice 2020-75 which opened the door for a SALT workaround. This notice provides Pass-Through Entities (PTEs), such as partnerships and S corporations, a Federal tax deduction in computing the PTE’s non-separately stated taxable income for amounts paid by the PTE for SALT that are imposed on the taxable income of the PTE passed through to its owners.
New York TSB-M-21(1)C (Issued 8/25/21)
Under TSB-M-21(1)C, a PTE can elect to pay a portion of the PTE owners’ NYS estimated taxes that are attributable to such owners’ share of the PTE’s taxable income. The PTE takes a Federal tax deduction for such taxes, which essentially passes through to the owners of the PTE. The PTE owners end up getting a Federal tax deduction for the NYS taxes which they would not otherwise get if such NYS taxes were not paid by the PTE. The owners of the PTE not only get their share of the tax deduction but can claim their share of the NYS taxes paid by the PTE as a credit against their NYS taxes. Eligible PTEs include only partnerships, S corporations and multi-member limited liability companies that have elected to be taxed as partnerships or S corporations.
Required Election and Tax Payments
For 2021 only, the PTE tax election is required to be made by October 15, 2021. The only way to apply is online, through the entity’s NYS Tax Department Business Online Services account. If the PTE does not have a Business Online Services account, an authorized person of the PTE will need to create one by October 15, 2021. Only an authorized person (i.e., an officer, shareholder, partner, member, etc.) of the PTE may make the PTE tax election on behalf of an eligible partnership or S corporation. Apparently, tax professionals may not make this election on behalf of their clients. However, we can work with you to set-up this Business Online Services account if you do not already have one.
The NYS Tax Department stated it will make forms available (online only) by December 15, 2021, for the PTE to pay the 2021 NYS taxes. Generally, paying the tax in 2021 is necessary in order to take the deduction in 2021. In addition, partners and shareholders must continue to make estimated tax payments as if they were not entitled to the PTE tax credit.
– Election for Years After 2021
For tax years beginning on or after January 1, 2022, the annual election must be made online by an authorized person on or after January 1 but no later than March 15. The election is required to be made by the due date of the first estimated tax payment (March 15th) for the respective year. Accordingly, if a PTE wants to make an election for 2022, it must do so by March 15, 2022. The election must be made annually and is irrevocable for the year in which it is made. Estimated tax payments equal to 25 percent of the annual required payment are required to be made on March 15th, June 15th, September 15th and December 15th.
– Estimated Tax Calculation
The estimated tax payments are calculated by taking the sum of all items of income and deductions that represent NYS taxable income, multiplied by the applicable NYS income tax rates. For NYS resident owners, NYS taxable income is all the net income from the PTE. For NYS nonresident owners, NYS taxable income is only the net taxable income of the PTE sourced to NYS. To avoid underpayment of estimated tax penalties, the PTE is only required to pay the lesser of 90 percent of the current year tax; or 110 percent of the tax shown on the return of the PTE for the previous taxable year. The tax rate to apply will range from 6.85 percent to 10.90 percent, as indicated in NY Tax Law and will be based on the PTE’s taxable income (not the partner/shareholder’s taxable income), as follows:
- 85 percent for PTEs with taxable income not over $2,000,000.
- $137,500 plus 9.65 percent of the PTE’s taxable income in excess of $2,000,000 and under $5,000,000.
- $426,500 plus 10.30 percent of the PTE’s taxable income in excess of $5,000,000 and under $25,000,000.
- $2,486,500 plus 10.90 percent of the PTE’s taxable income in excess of $25,000,000.
– Pass-Through Entity Tax Credit
An individual that is subject to NYS personal income tax, who is a partner or shareholder of an electing PTE that is subject to the PTE tax, is allowed a credit against their personal income tax. The credit is equal to the partner or shareholder’s share of the PTE tax paid. If the credit exceeds the individual’s tax due for the tax year, it is treated as an overpayment which may be either refunded or credited. A NYS addback equal to the amount of the PTE tax deduction claimed on the Federal tax return is required for any individual claiming the credit. An additional resident tax credit is allowed for any PTE tax paid to other states or local taxing authorities that is substantially similar to the PTE tax imposed by NYS.
Impact on Your Tax Bill
Owners of PTEs may be wondering how this election would affect their tax bill, and if it is worth the administrative burden. Consider this, a Married Filing Joint (MFJ) taxpayer with $1,000,000 in net income from their Partnership’s Schedule K-1 in 2021 may be able to save over $35,000 in Federal income tax. In this calculation, we take the $1,000,000 in net income, multiplied by the NYS PTE tax rate of 6.85 percent to obtain an additional Federal deduction of $68,500, which will directly reduce their non-separately stated income. As we use a Partnership in this example, we will assume the income from the K-1 would also be subject to Self-Employment (SE) tax, at a rate of 15.3 percent. The top individual tax rate for 2021 is 37 percent, which along with the SE portion, brings the total tax saving to 52.3 percent, or $35,826.
Although the PTE tax would be required to be added back to NYS income, there is a net zero impact for state purposes, as the PTE income for state purposes would wind up being the same as it would have been had the election not been made. This is just one example, and there are other factors that may impact this calculation (such as the Qualified Business Income [QBI] deduction), but we can clearly see the potential to reduce Federal income taxes by making this election.
If you have questions regarding how the NYS PTE tax may apply to you, feel free to contact me at firstname.lastname@example.org or 315-472-9127 x134.
Contributing author: Mickel Pompeii, CPA, CDA, is a tax partner with 13 years of experience in taxation and tax planning for individuals and closely held companies. He is responsible for overseeing tax engagements for a variety of the firm’s clientele, with a focus on manufacturing firms.