Understanding Pass-Through Entity Tax Election

2017 Tax Cuts & Jobs Act – State And Local Tax

The 2017 Tax Cuts & Jobs Act imposed a $10,000 cap on the State And Local Tax (SALT) deduction for taxpayers who itemize their deductions. To counter this limit, many states introduced the Pass-Through Entity Tax (PTET), allowing owners of pass-through businesses (partnerships, LLCs, and S corporations) an opportunity to shift the tax burden to their businesses and preserve deductibility.

Currently, 33 states (now including Indiana as of early 2023) have implemented PTETs, allowing business owners to make a PTET election.

What is PTET?

PTET allows business owners to pay state taxes on their business income through the business itself instead of their individual tax returns. This means that state tax payments become a business expense that can be fully deducted from the business’s federal income, rather than being limited by the $10,000 SALT deduction. In addition, business owners also receive a state tax credit to offset their individual tax liability by the amount of tax paid by the business.

Analysis From Your CPA

While PTET might seem straightforward, it's important to analyze the details with your CPA prior to making the election. PTET can often lead to higher state taxes since some states tax pass-through entities at higher rates than individuals. Additionally, some states may not offer a full tax credit, resulting in partial double taxation. But even with potentially higher state taxes, deducting PTET as a business expense can save you on federal taxes, including income tax, self-employment taxes, net investment income tax, and additional Medicare taxes depending on the business entity type.

Multistate Taxation and PTET

Business owners that operate in multiple states face additional complexities when considering a PTET election. The decision involves evaluating the impact of each state's PTET on potential federal tax savings, along with other factors related to electing PTET across state lines. These factors include additional filing requirements and whether the taxpayer's home state grants credit for entity-level taxes paid to another state, which may result in double taxation if the credit is disallowed.

Penalties and Interest

For the state of Indiana, because the PTET law was passed on a retroactive basis, potential penalties and interest that otherwise would be applicable will be waived as follows:

• For tax years that end on or before June 30, 2023, penalties and interest do not apply if the payment is made before August 31, 2024. (This includes filing amended returns to make the PTET election.)
• For years ended after June 30, 2023 an estimated payment must be made. The required estimate to avoid penalty and interest is 50% before December 31, 2024.
• Beginning in 2025, an entity is required to remit the lesser of 80% of the current year tax or 100% of the prior-year tax.   To date Indiana has not clarified the amount of penalties and interest.

It is important to note that these penalties and interest rules will vary in each state that allows PTET.

Conclusion

PTET can offer significant federal tax savings to a specific group of taxpayers: high-income owners of pass-through businesses in high-tax states who operate in a limited number of states to keep things less complex. Since the SALT deduction limit is set to expire after 2025, now is a great time to take advantage of PTET. For a detailed analysis and to see if PTET is beneficial for your particular situation, please get in touch with your DWD CPA.

Contributed By: John Richter, CPA | DWD CPAs & Advisors