Pass-Through Entity Tax (“PTET”)
With the enactment of the Tax Cut and Jobs Act in 2017 (“TCJA”), individual taxpayers were limited to a $10,000 state and local tax deduction for federal income tax purposes per year.
Taxpayers who live in states with higher tax rates (both income tax and real estate taxes) lost a significant benefit as a result of this limitation. In response, many states created a workaround mechanism, introducing a pass-through entity tax (“PTET”). There are now approximately 36 states (and New York City) with a PTET election option which allows qualified pass-through entities/S corporations to pay tax at the entity level; and these tax payments are fully deductible for federal income tax purposes. Individual members receive this benefit through their federal K-1, which reduces their federal taxable income by this deduction. States generally allow either a tax credit or a reduction of income to the members of the electing entity.
Many states allow a resident tax credit to the individual members for PTET taxes paid to other states. It is therefore crucial for entities to consider the PTET elections for planning purposes. This is especially true in cases where significant income is anticipated. Finally, careful planning is required with PTET elections as there is no conformity among states when it comes to PTET requirements. For example, California requires an installment payment by June 15 as a prerequisite to make the election. New York State and New York City require an election to be made by March 15 of the same tax year, and there is currently no relief for late elections. While PTET elections may be beneficial in most cases, there may be times where a PTET election does not make economic sense (e.g., states with nonrefundable PTET credits, individuals not being able to claim a PTET credit on their resident state, etc.).
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