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Reconsidering Pass-Through Entity Tax Elections

Pass-through entity (PTE) tax may be able to circumvent the SALT limitation.

Many states have enacted legislation to allow partnerships and S corporations to elect to have their income taxed at the entity level. This change was spurred to combat the $10,000 state and local tax (SALT) deduction limitation enacted by the Tax Cuts and Jobs Act.

What is the $10,000 SALT deduction limitation?

The Tax Cuts and Jobs Act (TCJA) implemented a limitation for individual taxpayers beginning in 2018 and through the end of 2025. Taxpayers — both married and single filers — who itemize their deductions can now only deduct up to $10,000 of state and local taxes on their individual income tax returns.

What is a pass-through entity tax election?

Pass-through entity (PTE) tax may be able to circumvent this SALT limitation. PTE elections allow the entity to deduct the state income tax expense paid at the entity level. Although the tax savings intent of all PTE elections is the same, each state’s PTE program varies in requirements, provisions and mechanics.

This workaround to the SALT deduction cap is enticing to many business owners. But is it the right move for your company? There is no universal answer to this question. Here are a few things to consider.

Credit or exclusion.

Many states impose the entity-level tax and provide a state tax credit to the owners to offset the tax paid on the same income. Several states, like Louisiana, effectively tax the pass-through entity like a corporation, and the owners exclude the income taxed in the PTE from their state individual income tax return. For companies with multi-state operations, analysis to determine how the various regimes will integrate is essential. A company may decide to elect in one state and pass on the election in another state. Administrative burdens should also be weighed.

Not all owners may benefit the same.

Generally, individuals will benefit from entity-level taxes. Estates, trusts, and corporations who are owners in these pass-through entities may not be eligible to have their entity pay taxes on their behalf. If there is a mix of both individual and non-individual owners, the PTE tax calculation may not benefit each owner the same. Likewise, if the company has a mix of resident and nonresident owners, some owners may benefit at the cost of others.

The election may be binding.

Depending on state, the election could be binding for a period of time. In others, it’s an annual election. Either way, you’ll need to know when and how to make the election.

There are still many uncertainties.

The IRS hasn’t addressed all potential issues with PTE taxes. In 2020, the IRS announced forthcoming regulations under which passthrough entities may deduct SALT imposed on them. It has been over 2 years, and yet no regulations have been issued.

Before you make a decision about PTE taxes, contact a tax professional at LaPorte. We are closely following updates concerning entity-level taxes and would be happy to discuss the risks and benefits to you, your business, and your co-owners.