State Pass-Through Entity Taxation Regimes: Analyzing Tax Consequences and Caveats of PTE Elections

Description

Many states are implementing PTE taxes in response to the 2017 Tax Act, which added a $10,000 cap on deductible state and local taxes paid by individuals. Surprisingly, the IRS announced that proposed regulations will be issued allowing a federal tax reduction for payment of PTE taxes (Notice 2020-75). This recently condoned treatment is already in place in at least 22 states and counting. Arkansas, Arizona, Colorado, Georgia, and Illinois have added PTE taxation regimes effective for 2022. Some states, including Texas and Connecticut, have mandatory PTE taxes, while others, like Louisiana and New Jersey, provide an election for payment of tax at the entity level.

Enabling taxpayers to deduct taxes paid above $10,000 can provide massive tax savings for individuals with state and local taxes exceeding the threshold and holding interests in partnerships, LLCs, S corporations, and occasionally, trusts. Many state guidelines incorporate a deduction that flows through as a non-separately stated item which can have disparaging results. In states with elective PTE taxes, nonresidents and partners in no- or low-tax brackets may be subjected to tax that they would not otherwise be obligated to pay.

In Louisiana, where PTE taxes are elective, once made, the election is binding for future years. Revocation requires filing a consenting application for termination with Louisiana's Department of Revenue. SALT tax practitioners must understand the tax regimes in states where PTE taxes are mandatory and analyze the tax consequences to owners in states where it is elective. Each state's method has its own nuances that must be understood to maximize overall tax savings.

Listen as our panel of SALT veterans explains PTE taxation methods, examples of common PTE taxation scenarios, and key caveats to consider before electing PTE treatment in states where payment of the tax is elective.