TAX PLANNING | 5/2/2024
More than 20 states now allow pass-through entities (PTEs) to elect taxation at the entity level. This approach helps members bypass the federal $10,000 limit on itemized deductions for state and local taxes (SALT), offering potential tax-saving benefits. At Chartered Consulting LLP, we provide insight into navigating these PTE tax elections to ensure optimal outcomes for entities and their members.
How State PTE Tax Regimes Work
State PTE tax regimes generally fall into two categories:
- Reduction of Adjusted Gross Income (AGI):
States like Colorado, North Carolina, and Wisconsin allow members to deduct their distributive share of PTE income from their AGI. - Tax Credits for Taxes Paid:
States like California, Illinois, and New York require members to include PTE income in AGI but offer a tax credit for their share of taxes paid by the PTE.
PTE regimes differ in:
- Election timing and binding nature
- Authority to make elections on behalf of the PTE
- Member filing requirements
- Compliance with withholding or composite return requirements
Key Considerations Before Making a PTE Tax Election
Not all PTE tax elections benefit every member. Thorough modeling is essential to evaluate combined federal and state tax consequences for the PTE and each member. Important questions include:
- What is the state’s PTE tax rate, and how is the tax base calculated?
- Are net operating losses (NOLs) allowed for the PTE or its members?
- For tax credits, how are they calculated, and are they refundable or carried forward?
- Can nonresident members claim tax credits for taxes paid by the PTE in their resident states?
Special Cases: Tiered Partnerships and Federal Considerations
Tiered Partnerships
Organizations with tiered structures face additional complexities:
- Can a PTE owned by another PTE make the election?
- How is the tax base calculated across tiers?
- Can an upper-tier PTE utilize NOLs or credits from a lower-tier PTE?
Federal Tax Considerations
Elective PTE taxes also carry federal implications:
- Timing of federal deductions depends on the PTE’s accounting method and election timing.
- State tax refunds attributable to PTE tax credits may count as taxable income.
- The tax expense of investment partnerships may face deductibility limitations.
Financial Statement Impacts
Elective PTE taxes may shift tax obligations from members to the PTE. This raises questions about whether taxes should be treated as equity distributions or income taxes under ASC 740. This determination varies by jurisdiction and specific circumstances.
Key Risks and Opportunities
One significant consideration is whether nonresident members can claim tax credits for PTE taxes paid to other states. If credits are unavailable, members may face higher state tax liabilities than the federal deduction benefit provides. Careful modeling and analysis are crucial to avoid unintended tax outcomes.
How Chartered Consulting LLP Can Help
At Chartered Consulting LLP, our State and Local Tax (SALT) professionals can guide PTEs through the complexities of state PTE tax elections. We provide:
- Detailed modeling of federal and state tax impacts
- Analysis for resident and nonresident members
- Insight into tiered partnership structures and federal implications
Contact us today to learn how we can help you evaluate PTE tax elections and maximize their benefits for your organization and its members.