Can New York State’s Pass-Through Entity Tax Program Help Reduce your Overall Tax Burden?
On April 19, 2021, New York Governor Andrew Cuomo signed the 2021-2022 budget bill into law. The budget supports through significant tax increases, the Governor’s $311 billion infrastructure plan, which is the largest and the most expansive in New York State’s history. One of the key favorable provisions of the law is a new, elective Pass-through Entity (“PTE”) Tax. This new tax is enacted as a work around to the $10,000 state and local tax (“SALT”) deduction limitation, which was implemented under the Tax Cuts and Jobs Act (“TCJA”). Since state income tax is imposed directly on the Pass-through Entity, the income tax paid is fully deductible by the entity for federal income tax purposes and not limited by the $10,000 cap, which does not apply to business entities. In addition, electing taxpayers provide their owners with a credit to be utilized on their New York State (“NYS”) income tax return equal to such owners’ appropriate share of the tax paid by the PTE.
The NYS PTE tax applies to tax years beginning on or after January 1, 2021 and is optional. Eligible entities include:
- Partnerships (other than publicly traded partnerships)
- Limited Liability Companies (but not single member LLCs)
- Subchapter “S” Corporations with a valid New York State “S” election in effect
The PTE Election
For calendar year 2021, the election to participate in the PTE program is due by October 15, 2021. After 2021, an annual election is required to be made by March 15 of the tax year (or 2 ½ months after the start of the taxable year for a fiscal year taxpayer). Once made, the annual election is irrevocable for that year.
NYS PTE Tax Rates
Applicable rates for the NYS PTE tax is based on the entity’s income:
- 6.85% for taxable income less than $2,000,000
- 9.65% for taxable income from $2,000,000 to $5,000,000
- 10.3% for taxable income over $5,000,000 to $25,000,000
- 10.9% for taxable income over $25,000,000
For partnerships, the income subject to the PTE tax would be:
- Residents – all income subject to tax
- Nonresidents – all income sourced to NYS
For S corporations, the income subject to the PTE tax for both resident and nonresident shareholders is only the income sourced to NYS. Distinguishing income subject to tax for residents and non-residents as in the partnership context is not available for the PTE for the fear of creating a second class of stock which would terminate the S corporation election.
If the owner’s individual tax rate is lower than the PTE rate, this may result in significant overpayments that can be offset against other income on the individual’s NYS return or result in a tax refund.
Key Advantages of the PTE Tax
- Tax Savings – The new PTE tax will provide a federal income tax savings. The tax paid will reduce the ordinary income allocated to each owner of the entity, making the PTE election beneficial for both income and self-employment taxes.
- AMT – PTE tax is not subject to the Alternative Minimum Tax (“AMT”). In the past, state and local tax treated as itemized deductions often subjected taxpayers to the AMT.
- A PTE Tax Credit – The owner is allowed a refundable dollar for dollar personal income tax credit on his/her NYS income tax return. Such person must be the electing partnership’s direct partner or member or the S corporation’s direct shareholder.
Other Considerations of the PTE Tax
- Cash Flow – For the 2021 tax year only, estimated payments for the NYS PTE taxes are not required to be paid in 2021, and instead a firm will be required to make a catch up payment representing the full 2021 PTE tax by March 15, 2022. There could be extensive cash flow issues as individuals are still required to pay 2021 estimated taxes throughout the year regardless of whether the PTE election is made. It is unknown at present, if a payment will be able to be made before year-end for cash basis taxpayers to provide a 2021 deduction vs. a doubling up of the deduction in 2022.
- Guaranteed Payment Partners – For firms that have partners that receive guaranteed payments (“GPs”), the legislation does not specify if these will be part of the PTE tax regime. If GP partners are included in the PTE regime, there may be economic consequences that will need to be considered.
- Other State Tax Credits –The law also provides a credit to NYS residents against their personal income tax for their share of any pass-through entity tax “substantially similar” to NYS’s PTE tax that is paid to another state or locality. However, eligible entities should consider whether the NYS PTE tax is creditable against the non NYS resident owner’s income tax return in their home state.
- New York City Tax – NYC taxes are not eligible for the PTE Tax.
- At present, many states have passed or have proposed similar legislation since the cost is not at the state level but at the federal level. Some, for example, have limited their legislation. California has only proposed this for Subchapter “S” Corporations deeming the partnership PTE tax too difficult or expensive to administer for other entities.
NYS’s new PTE tax may be an attractive option for certain taxpayers depending on their specific circumstances. At present, nothing is required to be done until October 15th for 2021. However, discussions on this topic should be ongoing and not wait until the deadline.
For more information, please contact your Anchin Relationship Partner.