On April 19, 2021, New York Governor Andrew Cuomo signed the New York State 2021/2022 Budget Bill into law, which includes a provision for a highly anticipated new elective Pass-Through Entity (PTE) tax.
In 2017 the TCJA enacted what is known as the “SALT CAP.” This “SALT CAP” limits the State and Local tax deduction to $10,000 for single taxpayers and married couples filing jointly and $5,000 for married taxpayers filing separately for tax years 2018 through 2025. As a response to this law, many States, including Connecticut and New Jersey, have enacted a PTE tax as a means to bypass the “SALT CAP” which permits partnerships and S-corporations to pay and deduct State and Local tax at the entity level. There has been some uncertainty as to whether the Internal Revenue Service would agree with the PTE tax regimes. However, the IRS clarified in Notice 2020-75 issued in November 2020 that PTE taxes are fully deductible at entity level. Based on the IRS’s favorable position, New York State has now joined the club of PTE tax regimes by enacting new Article 24-A.
While we still await NYS guidance on many details, following is a summary of information that is currently available.
Taxable years beginning on or after January 1, 2021
Who is Eligible:
Any partnership including Limited Liability Companies and other entities that are regarded as a partnership for Federal income tax purposes, except publicly traded partnerships, with a New York State resident partner or income sourced in New York that has a NYS filing requirement. An eligible S corporation are corporations, including Limited Liability Companies, which have made valid Federal and New York S corp. elections.
Each eligible partnership or S corporation can choose to participate in the PTE tax regime annually. However, once the election is made, it is irrevocable for the tax year. The annual election must be made by the first estimated tax payment due date, which is March 15 for the calendar year filers. Since this law was enacted after March 15, 2021, an election for tax year 2021 must be made no later than October 15, 2021. A fiscal year filer whose tax year ends before December 31, 2021 must also make the election by October 15, 2021. The election can be made by any member, partner, owner, or other authorized personnel for eligible partnerships and by any officer, manager, or shareholder of the eligible S corporations.
1) In the case of electing partnership, the sum of
i) All items of income, gain, loss, or deduction derived from or connected with NY source to the extent they are included in the taxable income of a nonresident partner subject to tax under Article 22; and
ii) All items of income, gain, loss, or deduction to the extent they are included in the taxable income of a resident partner subject to tax under Article 22.
2) In the case of an electing S corporation, the sum of all items of income, gain, loss, or deduction derived from or connected with NY sources to the extent they would be included in the taxable income of a shareholder subject to tax under Article 22.
|$1 – $2,000,000||6.85%|
|$2,000,001 – $5,000,000||$137,000 plus 9.65% of excess over $2M|
|$5,000,001 – $25,000,000||$426,500 plus 10.30% of excess over $5M|
|More than $25,000,000||$2,486,500 plus 10.9% of excess over $25M|
A direct partner or member in an electing partnership or a direct shareholder of an electing S corporation is allowed to take their direct share of PTE tax credit on his/her NYS personal income tax returns to the extent that the amount of PTE tax paid by the electing entity for the taxable year. Any excess PTE credit will be treated as an overpayment and can be credited or refunded without interest. In the case that a partner, member, or a shareholder is a disregarded entity for tax purposes, it will be disregarded for purposes of determining who is the direct partner or member of an electing entity. The information for both the disregarded entity and the owner of the disregarded entity who is ultimately claiming the credit must be reported on the annual PTE tax return to be qualified for the PTE tax credit.
Estimated Tax Payments:
The four equal estimated tax payments must be made on March 15, June 15, September 15, and December 15 of the calendar year prior to the year in which the due date of the annual PTE tax return falls. An underpayment of estimated tax safe harbor will be provided if 90% of the tax shown on the PTE tax return for the current year or 100% of the prior year’s PTE tax was paid. For the 2021 tax year, electing entities are not required to make estimated tax payments. Therefore, each partner, member, or shareholder of an electing entity will be required to make personal income tax estimated tax payments to avoid any underpayment tax penalty.
Annual PTE Tax Return:
Each electing entity must file an annual PTE tax return by March 15 following the close of the taxable year. This due date applies to the fiscal year filer as well. For example, if the electing entity is on a fiscal taxable year ending September 30, 2021, the due date to file annual PTE tax return for the entity is still March 15, 2022. A six-month extension to file an annual PTE tax return is available. Once the annual PTE return is filed, it may not be amended without the consent of or otherwise authorized by the Commissioner.
Each annual PTE tax return must include a certification of eligibility by an authorized individual, which must indicate that the entity had made a timely, valid election to be subject to PTE tax and that all statements contained on the annual PTE tax return are true. Additionally, each electing entity must provide information regarding the partner, member, and/or shareholder who is receiving the credit.
How Does the PTE Tax work?
Two NYS residents own an eligible partnership. Each has 50% ownership interest and the partnership earns taxable income of $2 million, all from NY sources. We are assuming a 40% Federal income tax rate and 10% NYS tax rate for both the PTE tax and personal income tax. For simplicity, assume that each partner has a $10,000 state and local tax deduction, which is derived from property taxes paid and offsets taxable income other than the pass-through income from the partnership.
The following summarizes comparison of a partner’s tax liabilities and credits in the above example:
|Without PTE Tax||With PTE Tax|
|Taxable Earnings||$1M (50% of $2M)||$900K (50% of $2M less $200K of PTE tax deduction at entity level)|
|Federal Income Tax||$400K ($1M x 40%)||$360K ($900K x 40%)|
|NYS Income Tax||$100K ($1M x 10%)||$100K ($1M x 10%) The PTE tax deducted at entity level would be added back to taxable earnings for the calculation of NYS income tax.|
|Total Tax Liabilities||$500K||$460K|
|PTE Tax Credit on NYS Tax Return||$0||$100K|
|Payment Due by the Partner||$500K||$360K|
There is a potential Federal income tax savings of $40K by a partner (or $80K for both partners).
Additional Information That May Help Decision Making:
- The 2021/2022 Budget Bill also increased the personal income tax rate on NYS’s existing highest tax bracket to 9.65% and created two new even higher income tax brackets (10.3% on taxable income from $5M to $25M and 10.9% over $25M) for the tax years 2021 through 2027.
- If you own a single member LLC or sole proprietorship, you are not eligible for the PTE tax. However, you can do tax planning to change your business to be taxed as a partnership or elect to be taxed as an S corporation so that your business may qualify for the PTE tax.
- Keep in mind that the “SALT CAP” could possibly be repealed altogether. Plus, Biden’s tax proposal of a 28% cap on itemized deductions for individuals earning more than $400,000 annually needs to be monitored for future development.
As always, our goal is to assist you in any way we can. Please contact us if you have any questions or want to consider making the required election.
Sincerely, The Partners and Staff at LHF