Connecticut Pass-Through Entity Tax and Guaranteed Payments: What Law Firms Need to Know
Effective for taxable years beginning on or after January 1, 2018, Connecticut replaces the pass- through regime with an entity-level tax. An earlier post Connecticut’s New Pass-Through Entity Tax: Practical Considerations summarizes the details of the Connecticut pass-through entity tax. Many law firm partners receive health insurance, interest on their capital accounts and other payments that are included as guaranteed payments on their federal K-1s. Here we will highlight issues and practical insights into the tax treatment of guaranteed payments under the Connecticut pass-through entity-level tax.
Guaranteed payments are not included in the calculation of the Connecticut pass-through entity tax. Therefore, law firm partners who are not residents of Connecticut are required to file an individual tax return in Connecticut solely to report guaranteed payments apportioned to Connecticut. This poses additional compliance costs and filing responsibilities for law firm partners. In reaction, the Connecticut Department of Revenue Services (“DRS”) offers an alternative arrangement that allows the pass-through entities to report and remit tax on behalf of each nonresident member, including the tax on the guaranteed payment. In exchange, the nonresident partner is not required to file a separate Connecticut individual income tax return. In order participate in this alternative arrangement, the firm must contact the DRS and enter into an agreement.
Law firms should evaluate the overall impact of taxing guaranteed payments at the Connecticut entity level as compared to the individual level, as there will likely be an additional tax cost. Other factors unique to the law firm may sway the firm to choose to (or not to) participate. If the arrangement would prove beneficial, interested firms should act swiftly to enter into an agreement, as the DRS may become inundated with requests. To enter into an agreement, email the DRS at firstname.lastname@example.org.
As we enter the 2019 filing season, law firms should consult with their advisors early in order to determine whether or not they should enter into the agreement with the DRS.