More and more states are implementing new passthrough entity taxes (PTETs), according to the AICPA State and Local Tax Technical Resource Panel (SALT TRP). The goal of these new PTETs is to act as a workaround for the $10,000 SALT Cap currently enforced for the federal deduction of state and local taxes. This cap has been in effect since 2018 and will be active through 2025 per the Tax Cuts and Jobs Act (TCJA).
Under Notice 2020-75, the IRS declared PTET payments to domestic jurisdictions are deductible for partnerships and S-corporations. This deduction is factored in when calculating the entity’s nonseparately stated income or loss. It is also not taken into account when applying the tax deduction cap to an individual shareholder or partner.
A PTET is either an elective or mandatory income tax applied by a city, county or state to a business entity. It enables tax-payers who own all or part of a pass-through entity to pay state or local taxes at the entity level, rather than at the individual level. Mandatory PTETs would be required to pay by the entity. Elective PTETs are optional, but may be recommended for a business owner to avoid the limitations of the federal “SALT Cap.” They can claim a tax deduction for the state taxes paid by the entity and avoid the federal limit on state tax deductions (otherwise known as the SALT Cap).
California is one of 36 states that have already enacted a PTET as of May 31, 2023. Some of these were effective as of 2022, some will be effective in 2023 or later, and Nebraska’s PTET is retroactive to 2018. Seven of these states have enacted PTETs this year, while three more states (Maine, Pennsylvania and Vermont) have PTET proposals/bills in process right now.
The AICPA SALT Deduction PTET Task Force has reached out to the IRS for guidance. These PTETs add extra complications to tax filings and federal deductions relating to state and local taxes. PTETs are being enacted throughout the country on a fast basis. It can be tricky for tax advisors and business entity owners/partners/shareholders to keep up with the ever-evolving tax laws.
Ultimately, a PTET in your state could be a tax advantage to you and your business. It is important to understand the tax rules and work with a tax planner who can help you maximize your deductions. To learn more about PTETs in your state and how they affect your business taxes, please contact Illumination Wealth today.