New York State Elective Pass-Through Entity Tax – SALT Cap Workaround
History of the SALT Cap
The Tax Cuts and Jobs Act limited the amount of state and local taxes (“SALT”) that could be included as a Federal itemized deduction to $10,000. This provision severely impacted individuals from high-SALT states including New York, California, Connecticut, Illinois, Massachusetts, and New Jersey. States have been trying to find ways to work around the $10,000 SALT cap ever since. High-taxed states, including New York, tried to establish workaround strategies which took various forms such as state and local sponsored charitable funds or trusts where individuals could make a charitable donation to such charitable funds or trusts in exchange for tax credits against their state and local taxes, essentially reclassing state and local state payments as deductible charitable contributions. In June 2019, the IRS issued final regulations which eliminated these workaround strategies.
IRS Notice 2020-75
On November 9, 2020, the 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 deduction in computing the PTE’s non-separately stated taxable income for amounts paid by the PTE for state and local taxes that are imposed on the taxable income of the PTE passed through to it owners. Therefore, SALT payments made by PTEs will not be a separate pass-through item and will not be part of the SALT cap calculation of the PTE’s owners. The notice applies to SALT payments made by the PTE on or after November 9, 2020.
The IRS intends to issue proposed regulations for clarification but has yet to do so.
New York State 2021/2022 Budget Act (SALT Cap Workaround)
The New York State (NYS) 2021/2022 Budget Act was signed into law on April 19, 2021. The Budget Act includes a provision that allows partnerships and NYS S corporations to elect to pay NYS tax at the entity level in order to mitigate the impact of the $10,000 cap on SALT deductions. This provision is not available for publicly traded partnerships. SALT paid by the PTE is deductible at the Federal level, allowing partners and shareholders to receive benefits of a full deduction for the amount SALT paid (deduction included in pass-through income). A credit against regular NYS income tax is passed through to partners or shareholders for their respective share of the PTE tax paid. This provision is effective for tax years beginning on or after January 1, 2021.
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. The election must be made by an authorized officer or owner of the PTE. The election cannot be made on an amended tax return.
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 15th, June 15th, September 15th, and December 15th.
Special Exception for 2021
For 2021 only, the PTE tax election is not required to be made until October 15, 2021, and the electing PTE is not required to make estimated tax payments for the 2021 taxable year until October 15, 2021. Partners and shareholders must continue to make estimated tax payments as if they were not entitled to the PTE tax credit.
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% of the current year tax; or 110% 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% to 10.90%, as indicated in NY Tax Law and will be based on the PTE’s taxable income (not the partner/shareholders’ taxable income) as follows:
- 85% for PTE’s with taxable income not over $2,000,000.
- $137,500 plus 9.65% of the PTE’s taxable income in excess of $2,000,000 and under $5,000,000.
- $426,500 plus 10.30% of the PTE’s taxable income in excess of $5,000,000 and under $25,000,000.
- $2,486,500 plus 10.90% 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/shareholder of an electing PTE that is subject to the pass-through entity tax is allowed a credit against their personal income tax. The credit is equal to the partner/shareholders’ 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.
Further Guidance Needed
Further guidance from NYS is needed in several areas which is anticipated to be issued soon. Guidance is needed on how the PTE makes an election for 2021 even though the partners/shareholders are required to continue making 2021 estimated tax payments. Guidance is also needed on how the estimated tax payments will become a Federal deduction on the PTEs tax return if the entity itself is not directly subject to the tax.
Note: NYS may be looking for both the partners/shareholders to pay 2021 estimated tax payments and the PTE to pay the tax again when making the election on October 15th. NYS would essentially be paid twice, with overpayments being floated until the 2021 tax returns are filed requesting refunds.
If you have questions regarding the NYS SALT workaround or how IRS Notice 2020-75 may affect your tax planning, contact Michael J. Reilly, CPA/ABV, CVA, CFF, CDA, at firstname.lastname@example.org or Shawn T. Layo, CPA, at email@example.com. You can also contact us directly at 315-472-9127.
Contributing author: Michael J. Reilly, CPA/ABV, CVA, CFF, CDA, is the managing partner for the firm. Mike has extensive experience in all areas of income and estate taxation, with a strong emphasis in individual and corporate tax planning, business valuations, ownership transition, litigation support and employee benefits. Mike concentrates in various industry specialties, including manufacturing, construction, automotive dealerships and professional service organizations.