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Latest Guidance to New York’s New Pass-Through Entity Tax
Latest Guidance to New York’s New Pass-Through Entity Tax
By: Stewart M. McGough, Esq.
Purpose. Earlier this year, legislation was passed and signed into law in New York to provide many NY taxpayers with a strategy to “work around” the provision under the federal tax law that limits individual taxpayers to a $10,000 deduction for state and local income and real estate taxes paid (the “SALT” limitation).
Example. Here’s an example showing how much additional federal taxes New Yorkers pay by application of the SALT limitation:
Assume Charlie is a partner in a NY partnership and that his share of the partnership’s 2021 net income is $400,000, which is also his adjusted gross income on his federal tax return (the amount appearing at the bottom of page 1 of the Form 1040).
New York’s average tax rate on taxable income of $400,000 is about 6.4%. Therefore, Charlie’s New York income tax liability would be about $25,600. If we assume his real estate taxes exceed $10,000, then none of his NY income taxes can be deducted on his federal return. Had they been deductible, Charlie would have saved between $8,200 and $9,000 in taxes (depending on whether he filed as an individual or jointly with his spouse).
The “Work-Around”. The new legislation enables the individual owners of “pass-through entities” – partnerships, LLCs and S corporations – to effectively regain the tax benefit by having the pass-through entity (which is not subject to the SALT limitation) opt into a new “pass-through entity tax” or PTET. This approach shifts the New York income tax liability to the pass-through entity, which pays the PTET (the tax brackets for this tax are similar to individual tax brackets). The law then grants a tax credit to each partner, member or shareholder (to be applied on his or her individual tax return) for his or her share of the taxes paid by the entity so that there is no “double tax” to both the entity and the individual owner.
The entity will deduct on its federal return the amount of NY taxes it paid, thereby reducing the amount of each individual owner’s share of the entity’s taxable income and in effect regaining for them the lost deduction under the SALT limitation.
In order to prevent the individual from in effect gaining a deduction on his or her NY return for New York taxes paid by the entity, the individual will have to add back into taxable income his or her share of the PTET paid by the entity.
Note the following:
- The work around is available to general partnerships and limited liability companies even if a corporation, or partnership, or LLC is an owner of the partnership or membership interest. However, the corporate owner, the partnership owner and the LLC owner are not eligible for any PTET credit. A trust is eligible if it is a direct owner of an interest in the pass-through entity, but it cannot pass the credits on to its beneficiaries. In any of these cases, there will need to be adjustments made in the amount of PTET to be paid by the partnership to account for this ineligibility.
- Each of the entity owners’ respective share of the PTET, and therefore the tax credit, is determined after all special allocations under the partnership or operating agreement have been accounted for. Absent any special allocations, the PTET is shared based on each owner’s percentage share of profits and losses. The shares allocated to owners of S corporations are based on their respective stock ownership percentages.
- If any owner is a non-resident of NY (i.e., resides less than half of each year in NY), then the entity must calculate separate pools, one consisting of the income, gains, losses and deductions that flow through to all NY residents, and the second pool consisting only of New York source income and the losses and deductions that apply to it, that are allocable to the non-resident. In other words, the non-resident is only taxable on NY source income, and the calculation of the PTET must take that into account.
- The PTET requires an annual election by the entity. To elect into the PTET for 2021, an authorized person of the entity elects through the Business Online Services account by October 15, 2021. For calendar years thereafter, the election must be made through that account by March 15 of the same year.
- For the 2021 year (only), even if the entity elects the PTET, the individual partners, members or shareholders must make estimated NY tax payments as if no election were made (the entity need not make estimated payments). This will most likely result in a refund due each individual after taking into account the credit allocated to the individual for the PTET paid by the entity.
- For years beginning in 2022, the entity must pay estimated NY taxes using the online application form. Estimated taxes will be calculated based on the lesser of 90% of the amount shown as due for the year, or 100% of the prior year’s PTET liability. These estimated payments cannot be credited to any other tax liability of either the entity or the individual owners.
We trust this will help you and your accountants in addressing the SALT limitation that has affected so many New Yorkers. After you have had a chance to review this, please do not hesitate to contact us.
