On-Demand: New York State & Other SALT Cap Workarounds for Law Firms
- Aug 5, 2021
This webinar addressed SALT Cap workarounds including the recently enacted New York State Pass Through Entity Tax and the New Jersey Business Alternative Income Tax.
Carolyn Dolci: Thank you so much for all of you for joining us today. The new SALT cap work-arounds have created excitement around the opportunity for significant tax savings. And after the law was released, both in New Jersey and then in New York, we received emails and calls from clients who wanted to make the election right away. I mean, the ink hadn't even dried. And as it happens with state taxation, we see many similarities from one state to the next, but we also see a lot of differences. And so today we want to share with you what we do know.
We also are going to make observations and pose questions on items that we don't have an answer for yet, but we want you to know about that also and to give some thought to it. So with that, I'm going to turn this over to Bill Gentilesco to start.
Bill Gentilesco: Thank you Carolyn. Good afternoon everyone. Our agenda for today, we're going to talk about the federal SALT cap that was enacted and the history of SALT deductions for tax purposes. We're going to talk about the New York state pass-through entity tax in depth. And we're going to touch on the New Jersey business alternative income tax or the BAIT. 2020 was the first year for the BAIT. And so for many taxpayers elections have been made, estimates have been paid in, some taxpayers have even filed BAIT returns, although most have requested an extension.
And there's been some bumps in the road or surprises that taxpayers brought to the attention of the Division of Taxation. I'm going to talk a little bit about those. Federal SALT deduction history. State and local taxes have been deductible on federal income tax returns since the inception of the federal tax. However, the Tax Cuts and Jobs Act included a code section that limits the SALT deduction for individuals to not more than $10,000 annually or $5,000 if married, filing separately. The TCJA SALT deduction limitation is set to expire after 2025. That's if Congress doesn't do anything in the meantime.
And the cap or the $10,000 limit negatively impacts individuals in high tax states including California, New Jersey, and New York among others. But the TCJA retained a provision that allows businesses to deduct state taxes without a limitation. And this trade or business exception incentivized high tax states to try to come up with these ways of maintaining a deduction. What we call SALT cap workarounds today. Connecticut was the first state to adopt a SALT tax workaround. In May of 2018, and that was retroactive, so 2018 was the first year, but the question via from practitioners at that point in time and taxpayers was, "Is the IRS going to allow this?"
The IRS had already shut down, if you recall, some towns and cities tried to convert their property tax to a charitable contribution. I think the IRS was quick to shut that idea down. But the SALT cap, they waited. It took a couple of years until November 2020 the IRS released Notice 2020-75. And prior to this notice I think many practitioners and businesses thought, "There's no way the IRS is going to allow these workarounds." But much to our surprise, Notice 2020-75, the IRS said that they intend to release proposed regulations regarding SALT tax workarounds.
And this notice was, I think, seven pages and it had a fair amount of detail about what those regs are supposedly going to say. And the notice says that they're going to clarify that state and local taxes imposed on and paid by pass-through entities are allowed as a deduction in computing the pass-through entity taxable income. And per the notice, the deduction will be allowed, without regard, to whether the SALT workaround is elective or mandatory or whether partners shareholders receive a partial or full deduction, exclusion, or credit based upon their share of the entities tax.
Further, the notice provides that pass-through entity income taxes are not included in the SALT limit for partners and shareholders who itemize returns on their 1040. So they'll get a business deduction if they're in a state that has a SALT cap workaround and you elected and they all still get their maximum of $10,000 on their federal 1040. So that's good news. Lastly the notice said that, "It's effective November 9th, 2020, but taxpayers can apply the rules for any year that begins after December 31st, 2017." So all good news there.
And here on this slide I have a list of all the states that have adopted a SALT cap workaround. We had seven states that had workarounds before the IRS released its notice and then 12, actually 11. Somebody told me this morning Massachusetts, it's been going back and forth between the governor and the legislature. It's not quite final yet. But there's 11 states and Massachusetts is close to adopting their workaround. And I think there's going to be more the rest of this year. I expect they'll be a few more states that have adopted this. In most cases it's not costing the states any money. It's just they're designed for a federal tax savings only. There is a cost to the state in terms of setting up new forms and processes for filing and that sort of thing, but the tax savings is really federal income tax savings only.
And before I turn it over to Mitch I'll just give you a little overview of how these SALT cap workarounds work generally. I mean, they're all a little different. Most are elective, although Connecticut is mandatory. If you're a pass-through entity doing business in Connecticut you have to file their pass-through tax return. You don't have a choice, but most of these are elective. Eligibility rules vary by state, particularly with respect to owners that are not individuals. In most cases the business pays the elective tax and gets a tax deduction and that thereby reduces the partners or the shareholders federal K1 income.
Usually partner, shareholders still have to file a personal income tax return with the states whether it's a resident state or their non-resident state. But in most cases they were able to claim a credit on their personal return, for their share of the pass-through entities tax. And most cases that credit is dollar for dollar for their share of the tax, but Connecticut only allows an 87.5% credit. So they're keeping a little bit of that benefit for themselves and I suspect we might see more of that going forward. I hope not, but it's possible. In most cases, if an election is made by a partnership or an S corp then all of the eligible partners must be included in that election.
But there's differences. It looks like California, they adopted their workaround a few weeks ago. It appears from that legislation that partners and shareholders might be able to pick and choose whether they want to be in that or not, but more details to come on that. In most cases though, if the entity elects, then all partners and all shareholders have to be part of that election.
Carolyn Dolci: Bill, just one thing here. I think you and me talked about it a little bit. Like the SALT cap is here until the end of '25. So what happens after that? Does the SALT cap go away-
Bill Gentilesco: Yeah.
Carolyn Dolci: And then the states have put all this energy into making these state tax deductions, state taxes and the deductions that go with it. Like who knows what's going to happen in the future.
Bill Gentilesco: Yeah. Exactly. I mean, what is it? Four, five years worth of benefit anyway.
Carolyn Dolci: Right.
Bill Gentilesco: Although, I mean, I guess technically Congress and the president could remove the cap at any time and then what happens? I think at this point I don't think we can assume that it's going to go away in '25, but in any case, four or five years of benefit is still worth quite a bit.
Carolyn Dolci: Right.
Bill Gentilesco: And with that, I'm going to turn it over to Mitch Novitsky for his presentation on the New York state pass-through tax. Mitch?
Mitchell Novitsky: Okay. Thank you Bill and Carolyn. I'm privileged to be a part of today's presentation. I'm going to be discussing the New York state pass-through entity tax and as following up on Carolyn's point earlier, we will be discussing and sharing with you everything we know and as soon as we find out additional items, we share it as quickly as possible. There are still some unanswered questions. I mean, what could happen at the federal level with legislation? The notice from the IRS 2020-75, there could be further guidance issue there. And New York joined the list of states with pass-through entity legislation, but as of this moment, New York state has not issued any guidance.
So some things we obviously know right from the legislation itself. Obviously and definitely be further guidance issued by New York state and there are various organizations including the New York State Bar Association that have posed various questions to the state and I think in the coming weeks we'll find out more and more. And why, and you'll see in a second, because October 15th is a very important date as far as the pass-through entity tax is concerned. So Bill mentioned earlier that in most states it's elective. Connecticut is an exception and New York state, the pass-through entity tax is elective for tax years beginning on or after January 1st, 2021.
It applies to partnerships except publicly traded partnerships, required to file a New York state return as well as New York S corporations. Now partnerships required to file a New York state return is not just partnerships that are doing business in New York. A partnership that has a New York resident partner is also required to file a New York state return and therefore, the PTE election would apply to partnerships with a resident partner even if they don't have any other connection with New York as well as S corporations that have income sourced to New York, which we'll get to in a minute.
I also want to stress, make sure before I forget, this is a New York state tax. It does not apply for purposes of your New York City taxes. Why do I say this? Because if you have an individual that is a New York City resident, partner, let's say. It can cover the state portion of the tax, but it won't cover the city portion of the tax. That's very important because when you make your estimated tax payments you've got to make sure that you are making payments on behalf of New York City because the pass-through entity tax will not apply to the city portion with regard to a city resident.
The PTET election is annual and irrevocable. You make it every year and once you make it, you can't revoke it. Now I mention before about further guidance. The election for 2021 must be made by October 15th, 2021. That is a very important date. We're still considering, entities are still considering. Do you make the election? Do you not make the election? As I indicated before, there's a lot of questions that need to be addressed. Many we can address. Some we can't. There will be further guidance by the state before October 15th. Right now even the mechanics of making the election has not really been fully detailed. When you make the election, identify the partners involved, the amount of credit allowed to each, resident or non-resident I'm going to get to in a second, but all the mechanics haven’t yet specifically laid out and we're going to hopefully see in the very near future further guidance, but remember that date. October 15th 2021.
Now that's for this year. As far as future years, it's due by the due date of the first estimated tax payment, which is March 15th when the election needs to be made. The election needs to be certified by authorized partner shareholder and included it with the return. As I mentioned before, those mechanics, there hasn't been detailed guidance in terms of how to go about with the specifics, but that will likely be forthcoming. And of course the election has to be made by a partner that has authority to bind the partnership as well as by an S corp shareholder that has authority to bind the S corporation.
At this time we're going to go to our first polling question.
Lexi D'Esposito: The New York state pass-through entity tax is mandatory beginning in 2021 for partnerships and New York S corporations. A, true or B, false. Please remember, in order to qualify for your CPE certificate you will need to remain logged in for at least 50 minutes and respond to three out of the four polling questions.
Mitchell Novitsky: Okay. So as we mentioned before, for New York state there is an election to participate in the pass-through entity tax. It is not mandatory. Only Connecticut, now there is constant legislation in other states. So you'd have to look at the specifics of each state and it's very, very important to make sure that you don't want to miss deadlines. So as I indicated, the New York deadline, I may say it five or more times during our conversation, is October 15th. If there are other states with elections it's very important that you turn that on an individual case by case basis. You saw all the states that have legislation. Many more are proposing it.
Be very careful of the election dates, if in fact they require a specific date in which to make the election. Now the pass-through entity tax return is due on or before March 15th following the close of the entities taxable year. And Bill and I were just looking beforehand. Even technically a fiscal year that ends before the March 15th, the same March 15th date applies to that. But March 15th is the due date for PTE return. Now, some questions come up. The election isn't due until October 15th, the return is due March 15th of the following year. Okay. What about estimated tax payments? So there are no pass-through entity tax estimates required for 2021.
But you have to consider the timing of the federal income tax deduction. To get a deduction for federal tax purposes for state taxes paid you have to make the payment generally in a cash basis tax payer by the end of the calendar year. So even though the PTE tax may not be due until March 15th, be very, very careful. You could make the election, but if you don't make the payment by year end 12/31, you could potentially lose the benefit of the federal income tax deduction, which is the whole basis for these pass-through entity taxes. So just be very, very careful about making a payment. If you do make the election likely before year end.
Bill Gentilesco: I'd just like to clarify that the IRS notice mentions that you get the deduction in a year of payment and that's been interpreted to be the case whether you're an accrual or cash. If you want to be certain you're going to get a deduction in '21, you're going to want to pay the New York PTET before December 31st, 2021. And the hope is that New York will have a mechanism set up to that. I expect that they will. I think they realize taxpayers are anxious to get that deduction. Thank you.
Mitchell Novitsky: Yes. Thank you. And we believe that obviously that will come out in terms of the guidance, how to make the payment, before year end for 2021. However, even though they are not requiring the pass-through entity to make the payment in 2021, they are requiring that estimates be made by the individual partners or S corporation shareholders on their respective estimated tax due dates. So you can't rely on the fact that you're going to make an election for the pass-through entity tax, you're going to make a payment at a certain point before year end.
Estimated tax payments were still due March 15th, June 15th, September 15th, and then at 12/15. You have to be very, very careful about making those estimated tax payments. Now the question arises, you going to make the estimated tax payments and the pass-through entity may also be required to make a significant payment before year end. That's a cash flow issue. We'll get into that in a bit, but if you do not make the estimated tax payments from an individual perspective, you could be subject to penalties.
Now after 2021, the pass-through entity makes the estimates and the pass-through entity estimates, we indicated when they're due and the estimates must equal 25% of the lesser of 90% of the current year tax or 100% of the prior years tax and the annualization of income method is not permitted in that case. For 2021 only, as I just mentioned, partner shareholders must continue to make New York personal income tax estimates without regard to the expected PTE credit. Otherwise estimated tax penalties apply. So be careful to make your estimated tax payments each quarter and also be careful if you are a New York City resident. This does not cover New York City taxes. So you have to make estimated tax payments for the city as well and that'll be on a going forward basis, even going forward into next year when the pass-through entity makes the estimated tax payments. It won't cover the New York City tax payments.
Now to who does the New York pass-through entity tax apply? It applies and it's imposed only on article 22 taxpayers. What are article 22 taxpayers? Generally individuals and some states and trusts that aren't taxed as corporations. Now as far as partnerships and S corporations, they're treated differently in terms of what income is included when they make the election. So for partnerships you draw a distinction between New York resident partners and non-resident partners. For New York resident partners the pass-through entity tax is imposed on all items of income included in taxable income under article 22.
So if you're a New York resident partner all the income that you receive from the partnership can be included in the pass-through entity tax. If you're a non-resident partner it's only the income that is sourced to New York state. So if the partnership, let's say, only 10% of it's business occurs in New York state, then only 10% of the income, which is the amount sourced to the non-resident partner, would be part of the pass-through entity tax. So for partnerships there's a distinction between resident partners and non-resident partners. Residents all income, non-residents New York source income.
As far as S corporations are concerned, doesn't matter if the shareholder is a New York resident or not a New York resident, the pass-through entity tax is imposed only on the New York source income. My understanding it could create a federal problem if you start discriminating between resident shareholders and non-resident shareholders. So for S purposes, it's only on the income sourced to New York state versus partnerships where the resident partners can elect it on all their income. Now once you file the pass-through entity tax return it cannot be amended without the consent of the commissioner or their representative. Remember, it's an annual election and it's irrevocable.
Once you make it, that's it. As we discussed before, partners and shareholders have to continue filing personal income tax returns. Now there is a possibility with New York of composite returns that's not filed in all cases. You get into your subject of tax at the highest rate. If you file a composite return and I know one of the issues that's being considered and we're going to get to whole lot of issues is if you file a composite return can you claim the PTE tax as a credit on a composite return? And that's really an unanswered question.
And another question that comes up, there's non-resident withholding potentially, there's a form that you can file in New York, the 2658-E, to exempt yourself from non-resident withholding. Does the pass-through entity tax have an impact on non-resident withholding? These are questions that I just saw recently, the New York State Bar Association proposed to New York state. But we're speaking in general, assuming that the individuals are filing their own specific returns, which would be the case in almost all cases.
You have to continue filing and making the estimated tax payments regardless of the fact that you're electing the pass-through entity tax. Now the New York state pass-through entity tax is claimed as a credit on the partners shareholders New York personal income tax return. Bill mentioned before, Connecticut, you don't get a complete credit, New York you get a complete credit for the taxes paid on your behalf on your return. Now what happens if the credit exceeds the tax due for the year? Then it's an overpayment to be credited or refunded to you. And of course, in 2021 that will likely be the case. Why? As we mentioned before, you have to make estimated tax payments during the year and at the same time the pass-through entity tax will likely make the election will need to make a payment before year end to get the federal tax benefit.
So you could have a lot credited towards your account. That money is refundable or credited to a future year, but that's one of the issues that comes up with a pass-through entity tax. I mean, we believe in most cases it's beneficial. Cash flow considerations could play a role only because you're making a lot of payments and you have to wait a period of time to get back some of the excess that you've paid in. The second question, we now come to our second polling question.
Lexi D'Esposito: Non-resident partners included in a New York state pass-through entity tax return must still file a personal income tax return with the state. A, true or B, false. And please remember, in order to qualify for your CPE certificate, you will need to remain logged in for at least 50 minutes and respond to three out of the four polling questions.
Mitchell Novitsky: Okay. And most of you got it right. The answer is true, you still have to file a return and for this year you still have to make the estimated tax payments. I mentioned before and I eluded to, but that's more of a detailed issue in terms of filing a composite return, but either way, it's a return on behalf of the non-resident partners. So the answer in this case is true, you must still file a return with New York state. Now as far as the credit for SALT workarounds, a New York state resident could claim a credit for other SALT workarounds. So let's say you're in New York and the entity is paying the pass-through entity tax to other jurisdictions.
Can you claim a credit for the taxes paid at the entity level in other jurisdictions on your behalf in New York. So New York state has indicated that, yes, they will provide a credit. I indicated for '21 the question as to what happens years before 2021, likely they would do the same, but they don't address years before 2021, but in 2021 and going forward, if the other state has a pass-through entity tax similar to New York, New York's will provide a credit to the New York resident for taxes paid by the entity in the other state.
Now, I mention before, making the election, one of the issues is potentially cash flow. The question is will other states provide a credit? Does every state provides a resident credit for taxes paid by the individual to another state? The problem with this pass-through entity tax from a resident credit perspective is it's paid by the entity on behalf of the individual. So some states could take the position. It's paid by the entity, it's not paid by you the individual. Other states could also take the position, well even if we give you a credit, you have to first subtract out the taxes paid by the entity on behalf of the individual.
So your credit than would be, in many cases, limited or almost negligible. So many states have not addressed this, but that is a second major question. We know that for New York purposes they'll provide a credit if you're paying PTE taxes to another jurisdiction to the resident individuals. Will the other states provide a credit to their resident individuals for pass-through entity taxes paid to New York or other states. That has to be determined on a state by state basis and some states at this point there's just not enough guidance as to that.
Presumably, though not necessarily, we had a discussion yesterday, the three of us. Presumably the federal benefit will outweigh the loss of the resident credit, but not in every single situation. So it's another item that needs to be addressed and you really have to look, if you're doing business in various states, in a state by state basis if you're a resident of other states, how your state will treat the PTE taxes. Now the PTE tax, in order to calculate the tax, the income is considered by the entity as a whole. So even though you as an individual partner, let's say, or shareholder may be in a lower bracket, they calculate the rates based on the higher bracket.
Remember, this is not that big of a deal in the sense that it's refundable and you'll get credited with any amounts overpaid, but as a result, there could be amounts overpaid. If, let's say, they're paying it on 10.9 and your tax rate is 6.85. Now we put together two examples and I got to give credit to Bill. In addition to being a great accountant, he also has artistic abilities. He put together these diagrams. Don't be surprised if one day you see these in the Metropolitan Museum of Art. Maybe not with the underlying notations, but they really help explain and give good examples of the mechanics.
The first diagram really outlines the general principles and the second diagram deals with some of the mechanics and then we raise a lot of questions based on the second diagram and we will gather as a group, raise some of the questions or unanswered questions and issues that we believe come up as a result of this pass-through entity tax. So the first diagram, as we mentioned before, it only applies to article 22 taxpayers. So you have ABC partnership. 25% partner is a C corp, 25% partner is a New York resident individual, 25% partner is a non-resident individual, 25% partner is another partnership.
So ABC can make the pass-through election, whether it does business or not, since it has at least one partner subject to tax, the New York resident. As I mentioned before, you have to file a return if you have a New York resident partner and just the fact that it has a New York resident individual partner, it can make the election. But of course it has more. So it also has a non-resident individual partner. Okay. So ABC, the pass-through entity tax will be imposed on all of the New York resident partners income and the New York source income of the non-resident partner. However, no pass-through entity is imposed on the C corporation. Okay.
C corporation is not an article 22 taxpayer. So there's no election with regard to that C. Now what about the partnership, XYZ partnership? There is nothing with regard to XYZ partnership, but remember, XYZ partnership may have its own partners. And XYZ partnership may be able to make its own PTE pass-through entity election if it has an article 22 partner. So when you have different tiers, you have to then look to the next level. And if there are individuals under that article 22 taxpayers, then you should be able to make the election with regard to that, but it's at the next level as opposed to the earlier level.
Now the next example deals with some of the mechanics more. The last example was more the general principles. This example deals with the mechanics. And once again, thank you Bill for these diagrams that help outline the issues. So you have ABC partnership. So A lives in New Jersey. Remember, we're talking for the New York pass-through entity tax. They have a 50% interest. B is a New York resident partner, has a 50% interest. And then C is a New York partner, has a 0% interest, but gets a $250,000 guaranteed payment because this issue has clearly come up, particularly as we're dealing with law firms.
So these are our assumptions and don't worry if you don't get all the specifics or if you're not familiar with some of these concepts, but we just want to show this diagram just so we can show you some of the mechanics of some of the issues that come up and hopefully, as we said, we'll get more and more guidance and more and more answers to questions hopefully in the near future. So ABC partnership has three individual partners, A, B, and C. Partnership A and B each have a 50% profit interest. C gets a $250,000 guaranteed payment. So ABC has a 10% New York state apportionment.
So that basically means that 10% of its business is being done in New York through this mechanics of the New York formula to determine the amount subject to tax in New York state. ABC makes two million dollars in 2021 after payment of all expenses including C's guaranteed payment. And ABC has a 10% New York state blended tax rate. Now let's try to take this on a partner by partner basis as to the amounts that should be allocated to each partner and then of course we'll raise some of the observations and questions that arise as a result of this. Okay?
So partner A's share is $10,000. Why? Partner A is a New Jersey resident. So you have two million dollars, they have a 50% interest, you multiply that by the 10%, which is the amount sourced to New York and you have a 10% tax rate. So that comes to $10,000. Partner B remember, if you're a resident it's on all your income. So it's 50%. Is their interest? Two million times 50%. Their tax rate is 10%. So their share of the New York pass-through entity tax would be $100,000. Partner C is $25,000, which is the guaranteed payment times the 10% tax rate. So ABCs total pass-through entity tax expense is $135,000 and the above amount reflects each partners New York pass-through entity credit.
So we allocated it to the separate partners. And of course, one of the issues that comes up, if this is in our observations and questions, in terms of room for special allocations because you have a situation where resident partners, more is allocated to them than non-resident partners. The general thought is that you should be able to have special allocations. There's no intent to evade any tax here or whatever. You just want to allocate separately and you have to make it up in different ways. But this is one of the questions that comes up because you're never going to have a situation where everybody's the same.
You're going to have residents and non-residents and then you're going to have some that don't have an ownership interest in terms of sharing in a percentage of the profits, but they're getting guaranteed payments. So I'm going to go through some observations. Carolyn came up with some other questions.
Carolyn Dolci: We've had a lot of discussions internally on this subject and we've got a lot of questions from clients. So I think probably one of the items we came up with is if you have a partnership agreement, you should look at your partnership agreement, at least with partner A and B and make sure there is a provision for you to make this special allocation. And if not, you may need to add something to your partnership agreement to handle that. We run into the guaranteed payment partner and we've also had a lot of conversations around that because the guaranteed payment partners income is creating this tax, but that person doesn't share in any profits of the firm. They don't have ownership percentage, they don't have a profit sharing percentage.
And do we think there's any ability to allocate the deduction to them or should it be treated as non-resident withholding? Relating more that it's based on the current guidance that it's probably closer to non-resident withholding to the guaranteed payment partner, but we don't have proposed regs on this notice. So we're not exactly sure what to do with the guaranteed payment partners, but many law firms have these types of partners and so it will be an issue that needs to be discussed and a solution will need to be found.
Mitchell Novitsky: Yeah. Very good points. I did see one of the questions with the New York State Bar Association. If you actually have a foreign, and when I say foreign, out of this country guaranteed payment partner, then the issue is, is the guaranteed payment included in federal taxable income because that's the driving factor as to whether it should be allocated to New York. But needless to say, there are a lot of questions that arise. Not all the answers have been addressed, but look for constant guidance to come in the near future. Some of the observations and thank you Carolyn, following up on her points, you have B receive $90,000 more of a payment than A.
So partner A's firm distribution should be 90,000 higher than B's distribution? I mean, these are questions and observations that come up. How should ABC allocate its 135,000 federal income tax deduction to the partners? Should C get any of the deduction? Should partner C's 25,000 New York pass-through entity payment correspond in credit be deducted from his guaranteed payment? We're going to have additional questions that come up, but there is another polling question that we're going to go to right now.
Lexi D'Esposito: A pass-through entity must be doing business in New York state to be eligible to elect the pass-through entity tax. A, true or B, false. Please remember, in order to qualify for your CPE certificate, you will need to remain logged in for at least 50 minutes and respond to three out of the four polling questions. (silence)
Mitchell Novitsky: Okay. This was a trick question. Most of you got it right, but remember, as I indicated before, if you have a situation with resident partners, you have to file a return. You're eligible for the pass-through entity tax. So even if you're not doing business in New York, but you have resident partners. The pass-through entity tax could apply. And you can make the election. Okay. Here are some more of the issues that we came up with and as I said, there's many, many issues with regard to the pass-through entity tax and the election.
The treatment of the federal income tax deduction for the resident versus non-resident partners and guarantee payment only partners. And we've discussed this and Carolyn talked about special allocations and potentially amending partnership agreement. I mean, these are all very key issues. Firm cash. So needed to pay the 2021 tax. As we've stressed, you're going to have to make the payment before the end of the year in order to get the federal tax benefit.
So that has to be considered. You have to make the payment before year end and then remember for next year, you make the payments each quarter. So then you're going to have to make a payment 3/15 for the first quarter of 2022. So this is just something. There's a lot that needs to be paid in a short period of time. And of course, the double payment in 2021. We talked about that. The partners and shareholders can't take, and I want to stress that. Some people say, "Well we're definitely making the election so why do I need to make estimates?"
You have to make estimates. Technically penalties will apply. So we have to go with that assumption. And as I mentioned before, a New York City resident, it doesn't apply. So you should be making estimated tax payments for 2021 regardless of whether you're making the PTET election.
Okay. Now another issue is you have resident partners and you're going to claim a credit for taxes paid to other states, but there's also payments being made to other states. And I mentioned before, this is on a cash flow concept, you wind up paying in and you include the pass-through entity, a lot more than 100%. It's creditable, you'll get the money back, but you likely won't get it back until at least October, potentially October of next year. So cash flow, and as I mentioned before, the potential issues with the resident credit are the two major areas that I see and then there's a lot of just unanswered questions.
Okay. Some of them more. Partners may be required to include the excess SALT deductions attribual to SALT work around and their federal income tax will come in later years. So you're getting the deduction, but what about if you paid in a lot more and you get a lot more being credited to you? So that could be taxable income in future years. As more states adopt SALT work arounds the likelihood of state and local deductions exceeding the partner shareholder state income tax liability increases. This is more likely for New York residents, state resident partners because you're paying in a lot and who knows what, in terms of the future, you're going to have to pick up some of the income that you might have gotten a deduction on this year.
Resident partners in other states might have their credit for taxes paid to New York state reduced. We talked about that. And I want to stress again, and then I'm going to turn it over to my colleagues in terms of other issues. I know Carolyn raised a whole bunch of issues with us, all great issues, before the call, that there will be more information coming in terms of forms, instructions, regulations. So please keep abreast of all that. We're keeping abreast of it daily. So there's a lot of changes and hopefully a lot of those questions will be answered as future guidance comes out.
Bill Gentilesco: Hi. Bill Gentilesco again. I'm going to be touching on the New Jersey business alternative income tax or the BAIT. 2020 was the first year for the BAIT. So taxpayers that wanted to have made the election was originally due, actually, before I get into New Jersey, this is our last question.
Lexi D'Esposito: State Tax work arounds are designed to reduce federal income taxes. A, true or B, false. And please remember, in order to qualify for your CPE certificate, you will need to remain logged in for at least 50 minutes and respond to three out of the four polling questions.
Bill Gentilesco: Okay. Most of you got this right. And SALT cap work arounds are designed to reduce federal income taxes and that's why I think you see so many states jumping onboard. They're able to give their residents federal tax savings without costing the states anything other than, of course, the compliance costs of administering a new tax. And some states are actually raising money with their SALT cap workaround. I mention Connecticut only giving a credit for 87.5% of the tax paid. I'm hoping not, but we might see more of that in the coming years.
But back to the New Jersey BAIT. 2020 was the first year. And so taxpayers that wanted to have made their New Jersey elections, the original due date of the election was March 15th 2021, but the state extended that a couple of times and I have to make a correction here. I have May 17th. They actually extended it one more time and it went all the way to June 15th. That the state had some technology issues and taxpayers as well. So they gave them multiple extensions. We'll see whether New York has some of the same issues that New Jersey had. Hopefully not.
But the date was extended to June 15th, 2021 to make your BAIT election or to file a return or to file an extension. Post 2020 we're back to the March 15th deadline. So if you're going to elect a 2021 New Jersey BAIT you got to do it by March 15th, 2022 or the 15th day of the third month following the close if you're a pass-through entity. The New Jersey BAIT uses an evenly weighted three factor formula and no market sourcing for apportionment. So it's the same apportionment that's used on a New Jersey partnership 1065. S corporations were surprised because S corporations, New Jersey CBT-100S, it's a single sales factor and market based sourcing.
But if an S corporation elects the New Jersey BAIT, they use three factor formula that partnerships use for the BAIT. And so you have a disconnect between a shareholder’s K1 income from the New Jersey CBT-100S versus their BAIT credit. In some cases, it's a lot more and in some cases it's a lot less. Another issue we found that for 2021 estimates are due, this is for calendar year 4/15, 6/15, 9/15, and 1/15, but again, you're BAIT election, according to the law, isn't due until March 2022. Well what taxpayers found that when they went online to make 2021 estimates, the system won't let you make an estimate for '21 unless you first make a BAIT election.
And that doesn't seem fair because the BAIT election isn't due until next year. But the good news is New Jersey allows partnerships and S corps to revoke their BAIT election on or before the due date of the return, which again, for calendar year would be March 15th. And another thing is that the date the Division of Taxation's guidance has been unfavorable with respect to upper tier entities. So let's assume I have an operating partnership and it's owned mostly by individuals but it also has…maybe it has an S corp partner, maybe it has a C corp partner, or maybe it has another partnership that's a partner.
The state has said that if the law or entity elects the BAIT and passes a credit up to a C corporation or an S corporation partner, that that partner cannot get a refund. It is not a refundable credit. It has to be used against that partners tax. Well, if you're an S corp in New Jersey, you're not really paying tax other than New Jersey minimum tax or maybe if you have a built in gain. And so not being able to get a refund is a problem. That credit is essentially trapped there until it expires. People with that structure have revoked their New Jersey BAIT for that reason.
C corporations, at least if they're profitable, they can apply it against their tax, but again, they can't get a refund of their BAIT credit. And tiered partnerships, the state did say if you're an upper tier partnership they will allow an upper tier partnership to claim a refund. But they're saying for the S corp and C corp partners that legislation would need to be enacted to allow for them to get a refund. They sympathize, but they're saying without legislation they can't fix that. And by the way, I should credit the New Jersey State Society for bringing up these issues.
They've had a lot of back and forth with the New Jersey Division of Taxation to try and clear up some of this stuff. So, because of this tiered entity issue, it's preferable to avoid making a BAIT, if you can, at a lower operating entity and to make it at an upper entity, if possible. I don't know if that's going to be possible. And also the division is considering changing some of these or trying to fix these, with legislation or, in some cases, perhaps regulations if they're able to do it withregulations. So we'll see.
The other issue with the BAIT is that the taxable income on the BAIT return, if you do a New Jersey 1065 or you do a New Jersey CBT 100S for an S corp, there's various addition and subtraction modifications to get to the gross income tax income that's reported on your New Jersey 1040. Things like an add-back for state income taxes or an add-back for accelerated depreciation and that sort of thing. The BAIT doesn't have those adjustments. And what taxpayers found was that when they made their estimates and they paid in the tax in 2020, they were expecting the BAIT return to have these modifications and when it didn't, it turned out that they either way overpaid or possibly underpaid.
Again, the division's considering fixing that going forward, but we'll see. And lastly, and this is going to be a continuing issue it appears. Partnerships that elect the BAIT and pay this pass-through tax must also continue to withhold tax on non-resident partners. So non-resident partners year after year are going to have withholding done for them, plus they're going to get a BAIT credit and they're going to be overpaid and requesting refunds from New Jersey. So it's not ideal from a cash flow standpoint.
Carolyn, that's all I had for this.
Carolyn Dolci: I think we're pretty close. We only have a couple minutes left. So I'm not sure we're going to be able to get through too much in the way of questions. I think maybe we're best to kind of stop here. We will go through the questions and do our best to respond to them. Thank you for joining us. I do want to tell you about we do have another session that's coming up in a couple weeks. And this is state tax ramifications of remote workers for law firms.
So when you get your CPE credit in an email, you will get the opportunity to sign up for this particular course also. And we'll do our best to answer all the questions in there. If you need to reach out to us, reach out to us separately. Thank you. I'll turn this over to Lexi.
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