In April 2021, New York State enacted legislation providing for a new elective pass-through entity (PTE) tax on partnerships and Subchapter S corporations.
The 2017 Tax Cuts and Jobs Act generally limits an individual’s deduction of state and local taxes to $10,000 per year (the “SALT Deduction Limitation”). In November 2020, the IRS issued Notice 2020-75, which held that state and local income taxes (whether mandatory or elective) paid by a partnership or a Subchapter S corporation would generally not be subject to the SALT Deduction Limitation.
The PTE tax is designed to be deductible for federal income tax purposes, thus enabling individual partners or shareholders of an electing pass-through entity to avoid the SALT Deduction Limitation with respect to their respective shares of state taxes attributable to the entity.
Mechanics of PTE Tax Election
The PTE tax is elective in nature, on an annual basis. Once made, the election is irrevocable for the taxable year in which the election is made.
With respect to 2021, the PTE tax election must be made on or before October 15, 2021. For post-2021 years, the election must be made no later than the first estimated payment date (March 15th for a calendar year taxpayer). While quarterly estimated payments are generally required for electing PTEs, estimated payments are not required for 2021.
An entity’s New York State taxable income is equal to the sum of (i) the taxable income of the entity allocable to New York resident partners or shareholders, and (ii) the New York-source income allocable to partners or shareholders who do not reside in New York.
PTE Tax Rate
The tax is imposed on the entity’s taxable income at the following rates:
6.85% for income not in excess of $2 million;
9.65% for income in excess of $2 million, but not in excess of $5 million;
10.3% for income in excess of $5 million, but not in excess of $25 million; and
10.9% for income in excess of $25 million.
Each individual partner or shareholder of an electing PTE will be allowed a New York State personal income tax credit for his or her proportionate share of the PTE tax paid by the entity. If the credit exceeds the tax due, it would be treated as an overpayment, which could be credited or refunded, without interest.
The PTE tax could be an effective way for owners of a pass-through entity to claim a federal income tax deduction with respect to the payment of New York State taxes.
In determining whether to make this election, an entity should consider, among other things, whether nonresident partners or shareholders would be allowed to claim a credit for the PTE tax in their state of residence.
Taxpayers are allowed to rely on Notice 2020-75 prior to the issuance of proposed regulations.