When the Tax Cuts and Jobs Act (TCJA) was enacted, it created, for the 2018 through 2025 tax years, an itemized deduction “cap” that limited the amount of state and local taxes an individual could deduct each year to a maximum of $10,000. In response to this limitation, and to protect residents from a potential increase in federal income taxes, many states considered and enacted a state-level income tax on pass-through entities (PTE) often referred to as a PTE tax. Historically, PTEs were not subject to an income tax—their owners were taxed at the individual level. Subjecting the PTE to tax lowers the income flowing from the PTE to its owners, thus lowering such owner’s federal income tax liability.
When these PTE taxes were initially enacted, there was significant ambiguity as to whether such PTE tax regimes would be accepted by the IRS. In November 2020, however, the IRS issued Notice 2020-75, essentially providing that PTE taxes are deductible at the entity level (e.g., these items are not subject to the $10,000 cap had these taxes been paid by the PTE’s owners).
Based on this favorable IRS position, on April 19, 2021, as part of its 2021/22 Budget Bill, New York State joined the list of states that have enacted similar tax laws and created their own PTE tax. This article will provide an overview of New York State’s optional PTE. CPAs should be aware of and familiar with its particulars in order to properly advise clients and employers.
New York’s PTE Tax
New York’s optional PTE tax, outlined under the newly enacted Article 24-A, is effective for tax years beginning on or after January 1, 2021. Eligible entities include any partnership under IRC section 7701(a)(2), other than a publicly traded partnership pursuant to IRC Section 7704, including a limited liability company treated as a partnership for federal income tax purposes—as well as any New York S corporation, including a limited liability company treated as an S corporation for federal income tax purposes that is otherwise eligible. The following are some of the key provisions of the New York PTE tax.
To file and pay PTE tax, an eligible partnership or S corporation must make an irrevocable election by the first estimated payment due date, which is March 15 of the calendar year prior to the year in which the PTE tax return is required. The election is made annually and will be effective for the current taxable year. For the 2021 tax year only, an election must be made by October 15, 2021. A fiscal-year filer is required to make the election, either by October 15, 2021 or if the end of the entity’s taxable year falls before the December 31, 2021, calendar year-end.
Estimated tax payments.
Electing entities are required to make four equal estimated tax payments for each quarter of a calendar year. To avoid penalties, total payments should be the lesser of 90% of the current-year tax or 100% of the prior-year tax. Electing entities can make advance payments prior to the payment dates. A fiscal-year filer is required to follow the same estimated tax payment due dates as a calendar-year filer. For the 2021 tax year, estimated payments are not required. A fiscal-year filer whose final day of the taxable year is in 2021 and makes a PTE election is considered a 2021 tax-year filer and is not required to make an estimated payment for this period.
A partnership’s New York State taxable income is the sum of the entity’s adjusted net income (all items of income gain, loss, or deduction) allocated to the state to the extent included in a nonresident partner’s taxable income and adjusted net income to the extent included in a resident partner’s taxable income. Similarly, an S corporation’s New York State taxable income includes “all items of income, gain, loss, or deduction derived from or connected with New York sources to the extent they would be included in the taxable income of a shareholder subject to tax under Article 22” [NYS Tax Law Section 860(h)].
The tax is imposed on the partnership or the S corporation’s taxable income at the following tax rates:
- 6.85% on income up to $2 million
- $137,000 plus 9.65% for income over $2 million up to $5 million
- $426,500 plus 10.30% for income over $5 million up to $25 million
- $2,486,500 plus 10.90% for income over $25 million.
A tax credit is available for a direct partner or shareholder of an electing PTE, and the credit for each individual is equal to her share of the PTE tax paid. If an individual is a partner/shareholder in multiple electing entities, her total credit is equal to the sum of such credits calculated separately for each entity. If the credit exceeds the tax due for the taxable year, it should be treated as an overpayment, which can be credited or refunded without interest. Furthermore, any individual claiming a tax credit for PTE taxes paid must have a corresponding New York addback of the amount of the PTE tax deduction (i.e.., while the PTE tax is deductible in computing a PTE owner’s federal taxable income, it is not allowed as a deduction in computing such owner’s New York State taxable income).
Moreover, Article 24-A also clarifies that a resident credit will be allowed for any PTE tax paid that is “substantially similar” to New York’s PTE tax. The credit will be in proportion to the partner/shareholder’s direct share of the PTE tax paid, and any excess credit is not an allowable overpayment or refund.
On or before March 15 of the year following the close of the taxable year, an electing entity must file an annual return. A six-month election to file the return may apply as needed. Each return must include a “certification of eligibility” by an authorized individual stating that 1) a timely election was made, and 2) all statements are true. In addition, the return must identify all partners, members, or shareholders of the electing entity eligible to receive credit. Once filed, such returns may not be amended without the consent of the commissioner.
An electing partnership or S corporation that is a fiscal-year filer is required to file a return on or before March 15 following the close of the calendar year that includes the final date of the entity’s taxable year. For example, a fiscal year filer whose period-end is June 30, 2021, must file its PTE return by March 15, 2022.
Determining the Benefit
CPAs must carefully evaluate whether electing PTE status for a flow-through entity would be beneficial—that is, each PTE and its owners should weigh the benefits of making an irrevocable election to be taxed as a PTE, comparing the savings in federal income taxes to any savings, or costs, at the state level. In addition, any disregarded entity wholly owned by an individual and reported on federal Schedule C should also consider the potential benefits of becoming a multimember PTE. These considerations are especially important given the different tax rates—not just for federal income tax purposes, but also the different tax rates enacted for the PTE tax versus New York State individual income taxes. The authors anticipate further guidance to be forthcoming from the state, so tax preparers are advised to pay careful attention to future developments.