A majority of states have now adopted the pass-through entity tax (PTET). In fact, 36 of the 41 states which impose state income taxes have adopted some form of a PTET tax rule. The PTET enables owners of pass-through business entities (partnerships, S-corporations and multi-member LLCs) to navigate around the $10,000 limit on state and local taxes (SALT).
A pass-through entity (PTE) can opt to pay state income tax on its business income, which would otherwise pass onto the business owners. The entity is then able to claim a federal business expense deduction for their state income tax payments. In turn, the state allows the owners to claim a credit or a deduction for these taxes, thus avoiding the SALT limit on some or all of their pass-through income.
Ultimately, the PTET gives business owners a financial benefit. They can use the federal deduction against their state income tax and maximize tax savings on eligible business income.
So far in 2023, seven new states have added a PTET program. Indiana, Iowa, Kentucky and West Virginia have made their PTETs retroactive to 2022. Nebraska’s is retroactive all the way back to 2018. The other two states, Hawaii and Montana, added PTETs that are not retroactive.
In order to qualify for a PTET in all active states, the business entity must be an S-corporation, partnership or multi-member LLC taxed as a partnership. Only these entities can elect to pay the state PTET and claim the federal deduction. Business entities not eligible include: sole proprietorships, single-member LLCs taxed as sole proprietorships, C-corporations, trusts in most states, and LLCs taxed as C-corps.
The deadline for PTET election will vary from state to state and paying the state PTET is completely optional in all eligible states other than Connecticut. In most states, a PTET election is binding on all of the entity’s owners. Individual owners cannot opt out, except in the states of Arizona, California, New York and Utah. These four states do allow individual PTET election.
Before electing for PTET or making any tax deductions, it is very important to understand the specific tax rules applying to your business entity and your state. It can get complicated and you don’t want to make any mistakes if you want to avoid tax penalties or audits. Illumination Wealth is here to help with all your business tax planning needs. Contact us today to learn more about PTET benefits and to see if this is the right tax strategy for you and your business.