Has Your Company Elected Into the New York State Pass-Through Entity Tax (PTET)? Additional Election Benefits to Consider for 2022
Why Was the Pass-Through Entity Tax Needed?
On December 20, 2017, the Tax Cuts and Jobs Act (TCJA) was passed, limiting the amount of state and local taxes that could be deducted as a federal itemized deduction to $10,000. The $10,000 limitation severely impacted individuals from states with high state and local income taxes, including New York State. Since the passing of the TCJA, several states began trying to find means to work around the $10,000 state and local income tax deduction cap. In June of 2019, the Internal Revenue Service (IRS) issued final regulations that eliminated several of the state workaround strategies.
On November 9, 2020, the IRS issued Notice 2020-75, which created a new avenue for a state and local income tax workaround. The notice provides pass-through entities, such as partnerships and S corporations, a federal deduction in computing the pass-through entity’s non-separately stated taxable income for amounts paid by the entity for state and local taxes that are imposed on the taxable income passed through to the entity’s owners.
What Is the Pass-Through Entity Tax?
In response to IRS Notice 2020-75, on April 19, 2021, with the 2021-2022 Budget Act, New York State included a provision allowing pass-through entities to elect to pay New York State tax at the entity level. By making the election, a pass-through entity tax is imposed on pass-through entities, which is paid by the entity and deemed to be fully deductible by the business for federal income tax purposes. A corresponding refundable tax credit against regular income tax is passed through to the partners or shareholders for their respective share of the pass-through entity tax paid.
New York State allows a pass-through entity tax (PTET) election, available to partnerships and New York S corporations, effective January 1, 2021. While the 2021 retroactive election was required by October 15, 2021, for all subsequent tax years, the annual election will be required by the due date of the entity tax return, March 15. For tax years beginning on or after January 1, 2022, estimated tax payments equal to 25% of the annual required payment are required to be made on March 15, June 15, September 15 and December 15.
The PTET is imposed on all items of income gain, loss or deduction to the extent such an amount is included in New York State taxable income for residents and nonresidents of New York State. The tax rates applied to the pass-through entity income range from 6.85% to 10.90%. For pass-through entities, the PTET is 6.85% of taxable income for income of $2,000,000 or less, $137,500 plus 9.65% of income more than $2,000,000 and under $5,000,000, $426,500 plus 10.30% of income more than $5,000,000 and under $25,000,000, and $2,486,500 plus 10.90% of income more than $25,000,000.
For tax years beginning on or after January 1, 2021, New York State allows a resident tax credit against New York State personal income tax for any PTET imposed by another state.
Improvements to the Pass-Through Entity Tax (PTET) For 2022
With the passing of the New York State 2022-2023 Budget Bill, additional benefits were created for entities electing to participate in the New York State PTET. One major benefit was created for S corporations. The pass-through income generated by an S corporation is apportioned to each applicable state based on the company’s state apportionment percentage. For example, a New York State construction company, owned 100% by New York State residents, established as an S corporation, which conducts 100% of its business outside of New York State, would have little benefit from electing the New York State PTET for 2021, since the company’s income would be allocated outside of New York. However, the New York State 2022-2023 Budget Bill has created two classifications for S corporations for New York State PTET purposes, an “electing standard S corporation” and an “electing resident S corporation.”
Prior to the changes for 2022-2023, in the example discussed above, for 2021, the company would have followed the rules of an “electing standard S corporation,” whereas only New York source S corporation income flowing through to shareholders was subject to the New York State PTET. In the example where 100% of the business is sourced outside of New York State, a New York construction company would have received little to no benefit for electing the New York State PTET in 2021. Under an “electing resident S corporation,” an S corporation must certify that at the time of its annual PTET election, all shareholders are New York State residents, for whom the company elects to calculate the New York State PTET based on the sum of all items of income, gain, loss or deduction to the extent that such items are included in the taxable income of the shareholders. In making the “electing resident S corporation” election, a New York State S corporation, 100% owned by New York State residents, conducting 100% of its business outside of New York State, would have the option to elect for all the company’s income be subject to New York State PTET, to the extent such income is included in the taxable income of resident shareholders. The new election, for eligible resident S corporations, will increase federal tax savings due to a higher PTET deduction, as well as help alleviate the resident shareholder’s New York State income tax burden.
Is It Too Late To Make the Election for 2022?
No. While previous legislation required the 2022 PTET election to be made by March 15, 2022, the New York State 2022-2023 Budget Bill has extended the 2022 election for all pass-through entities. Partnerships and S corporations that failed to make the PTET election by March 15, 2022, now have an extended due date of September 15, 2022, to make the election for the 2022 tax year. If you have not yet made the New York State PTET election for 2022 and are eligible for the additional benefits noted above, we strongly suggest reaching out to us at Dannible and McKee, LLP or to your current tax advisor to assist you in determining your company’s potential benefit.
Contributing author: Kaitlyn L. Mariano, CPA is a tax manager at Dannible & McKee, LLP. Kaitlyn has over 10 years of experience providing tax and consulting services to a wide range of clients, specifically within the construction and manufacturing industries. For more information on this topic, you may contact Kaitlyn at email@example.com or (315) 472-9127.