Update on State Pass-Through Entity Taxes Beating the SALT
Tax PlanningState pass-through entity taxes (PTET) have swept the nation and are now the rule, not the exception.
Such taxes enable owners of pass-through businesses to legally avoid the $10,000 annual limit on state and local taxes (SALT).
Key point. Adopting a PTET regime costs states nothing and benefits pass-through business owners.
How It Works
The idea behind the PTET is simple: A pass-through entity (PTE), such as a multi-member LLC, partnership, or S corporation, elects to pay the state income tax due on the PTE’s business income that would otherwise have passed through the PTE and been paid by the PTE’s owners on their personal tax returns.
The PTE then claims a federal business expense deduction for the state income tax payments.
The PTE’s deduction for state income taxes is not subject to the $10,000 SALT limit because the limit does not apply to taxes imposed at the business-entity level. Depending on the state, the PTE owners then either
- take a state-income-tax credit for the tax paid by the PTE, or
- reduce their taxable income for state purposes by their share of the PTET.
Either way, the PTE owners effectively benefit from a federal deduction for all the state income tax due on their pass-through income, even if it is far more than the $10,000 SALT limit.
Although the PTET concept is simple, its implementation has not been. Unfortunately, each state’s PTET is different.
There is no model PTET legislation to guide the states, so each state has devised its own PTET. The result is a confusing hodgepodge. We explained PTET basics in two previous articles:
- Defeat the $10,000 SALT Cap with the PTE Tax (Part 1)
- Defeat the $10,000 SALT Cap with the PTE Tax (Part 2)
Here’s an update on the latest changes since those articles.
36 States Have Adopted a PTET
Of the 41 states that impose income taxes, 36 have adopted some form of PTET. Maine,1 Pennsylvania, and Vermont have pending PTET legislation that has yet to be approved. The only states with income taxes that have no enacted PTET or pending legislation are Delaware and North Dakota.
Seven new states have enacted a PTET thus far in 2023:
- Hawaii
- Indiana
- Iowa
- Kentucky
- Montana
- Nebraska
- West Virginia
Most of these states have made their PTET retroactive. Indiana, Iowa, Kentucky, and West Virginia have made their PTET retroactive to 2022. Nebraska’s new PTET is retroactive to 2018. The Hawaii and Montana PTETs are not retroactive.
Of course, a PTE such as a multi-member LLC or partnership cannot amend its federal tax returns as far back as 2018 to deduct a state PTET paid by the PTE. The federal deadline for amending partnership returns is within three years after the date the return was filed or after the filing deadline for the return, excluding extensions—whichever
is later.
To avoid this problem, Nebraska’s PTET law does not require prior returns to be amended. Instead, PTEs may elect to pay prior-year state income taxes during 2023, 2024, or 2025, which will generate a federal-income-tax deduction for the year. A PTE’s payment of these taxes will also generate a refundable credit for its owners, equal to their pro rata or distributive share of the Nebraska income tax paid by the electing PTE.
Colorado has adopted a similar approach for its PTET, which is retroactive to 2018 as well. Starting September 1, 2023, pass-throughs may retroactively elect to pay Colorado income taxes on behalf of the owners starting with 2018. Taxpayers will have until July 1, 2024, to apply for this retroactive election.
The following chart shows which states have enacted a PTET. Almost all these states have provided online guidance that should be consulted.
State / Year PTET Took Effect / State PTET Statute State PTET Guidance:
Alabama
2021
Ala. Code Section 40-18-24.4
FAQ for Electing Pass-Through Entities
Arizona
2022
Ariz. Rev. Stat Ann. Section 43-1014
Pub 713, The Arizona Pass-Through Entity
Arkansas
2022
Ark. Code Ann. Section 26-65-103
Pass-Through Entity-Level Tax: Frequently
California
2021
Cal. Rev. & Tax Code Section 19900
Pass-Through Entity (PTE) Elective Tax
Colorado
Retroactive to 2018
Colo. Rev. Stat. Section 39-22-343
DR 0106 Booklet - Partnership or S Corporation
Connecticut
2018
Conn. Gen. Stat. Section 12-699
Pass-Through Entity Tax Information
Georgia
2022
Ga. Code Ann. Section 48-7-23(b)
HB 149 Pass-Through Entity Tax FAQ
Hawaii
2023
HI Rev. Stat. Section 235 (S.B. No. 1437)
None
Idaho
2021
Idaho Code Ann. Section 63-3026B
Illinois
2021
35 ILCS 5/201(p)
Pass-Through Entity Information (Publication 129)
Indiana
Retroactive to 2022
Ind. Code Ann. Sections 6-3-2.1-1 et seq.
Iowa
Retroactive to 2022
Iowa Code Sections 422.11,422.16C
(2023 Iowa H.F. 352)
None
Kansas
2022
K.S.A. 79-3220
2022 Kan. H.B. 2239
Kentucky
Retroactive to 2022
KRS (2023 Ky. H.B. 360)
Louisiana
2019
La. Rev. Stat. Ann. Section 47:287.732.2
Revenue Information Bulletin No. 19-019
Maryland
2020
Md. Code Ann. Tax Gen. Section 10-102.1(b)(2)(ii)
Maryland 2022 Form 511—Electing Pass-
Through Entity Income Tax Return Instructions
Massachusetts
2021
Mass Gen. L. Ch. 63D Section 2
Elective Pass-Through Entity Excise
Michigan
2021
Mich. Comp. Laws Section 206.813
Minnesota
2021
Minn. Stat. Section 289A.08(7a)
Mississippi
2022
2022 Miss. H.B. 1691
Guidance on Pass-Through Entity Election
Missouri
2022
Mo. Rev. Stat. Section
143.436
Montana
2023
2023 Mont. S.B. 554
Montana Pass-Through Entity Tax
Nebraska
Retroactive to 2018
Neb. Rev. Stats. Section
77-2727(6) (L.B. 754)
None
New Jersey
2020
N.J. Rev. Stat. Section
54A:12-3
Pass-Through Business Alternative Income Tax
New Mexico
2022
N.M. Stat. Ann. Section 7-3A-10
New York
2021
N.Y. Tax Law Section 868
Pass-Through Entity Tax (PTET)
North Carolina
2022
N.C. Gen. Stat. Section 105-154.1
Important Notice Regarding North Carolina’s Recently Enacted Pass-Through Entity Tax
Ohio
2022
Ohio Rev. Code Ann. Section 5747.38
Electing Pass-Through Entity: IT 4738
Oklahoma
2019
Okla. Stat. Ann. tit. 68, Section 2355.1P-4
Form 586, Oklahoma Tax Commission Pass-Through Entity Election Form (Revised 2022)
Oregon
2022
2021 Or. S.B. 727 Section 3
Pass-Through Entity Elective (PTE-E) Tax
Rhode Island
2019
R.I. Gen. Laws Section 44-11-2.3
South Carolina
2021
S.C. Code Ann. Section 12-6-545(G)
Utah
2022
Utah Code Ann. Section 59-10.1403.2
FAQs—2022 House Bill 444—Federal State and Local Tax Deduction Workaround
Virginia
2021
Va. Code Ann. Section 8.1-390.2
Elective Pass-Through Entity Tax Guidelines
West Virginia
Retroactive to 2022
2023 W.Va. S.B. 151
Information About the Pass-Through Entity Tax (SB 151)
Wisconsin
2019
Wis. Stat. Section 71.21(6)
Pass-Through Entity-Level Tax:
PTEs Eligible for the Election
As the phrase implies, only pass-through entities are eligible to elect to pay a state PTET. In all states, these include partnerships, S corporations, and multi-member LLCs taxed as a partnership or an S corporation.
Sole proprietorships or single-member LLCs taxed as a sole proprietorship are not eligible. A single-member LLC can become eligible only by electing to be taxed as an S corporation, or by acquiring an additional member and becoming a multi-member LLC taxed as a partnership.
The election is also not available to C corporations, trusts (in most states), or LLCs taxed as a C corporation.
Many states don’t allow a PTE to make a PTET election if it is owned by another PTE. But some states are amending their PTET rules to permit tiered partnerships to make the election.
For example, North Carolina recently amended its PTET law to permit PTEs owned by a partnership or an S corporation to make a PTET election, starting with the 2022 tax year. More and more states are likely to make this change.
Deadline for Making the PTET Election
No PTE is required to pay a state PTET; it must elect to do so. (The only exception is Connecticut, where the state PTET has been mandatory since 2018. But the Connecticut PTET will become elective starting in 2024.)
The due dates for making the PTET election vary from state to state:
- Due date for filing return. In many states, the PTET election must be made by the due date for filing the PTE’s state income-tax return, including extensions. For calendar-year PTEs, this is usually March 15 or April 15 (plus any extensions). These states include Arizona, Arkansas, California, Georgia, Idaho, Illinois, Indiana, Kansas, Maryland, Massachusetts, Missouri, Montana, Nebraska, New Jersey, New Mexico, North Carolina, Oregon, Virginia, and West Virginia.
- March 15. Some states impose a PTET election deadline of the 15th day of the third month following the close of the PTE’s tax year—March 15 for calendar-year PTEs. These states include Alabama, Connecticut, Michigan, Minnesota, Mississippi, Rhode Island, South Carolina, and Wisconsin.
- April 15. In the following states the deadline is the 15th day of the fourth month following the close of the PTE’s tax year (April 15 for calendar-year PTEs): Colorado, Kentucky, Louisiana, and Ohio.
- New York. For 2023 and later, the election must be made between January 1 and March 15, the due date for the first estimated tax payment.
- Oklahoma. The due date is no later than two months and 15 days after the beginning of the year— March 15 for calendar-year PTEs.
- Utah. The PTE election is due the last day of the PTE’s taxable year. (Yes, you read that correctly— you likely have to estimate the tax.)
- Virginia. Virginia has delayed implementation of its PTET until at least October 15, 2023. Before that date, the Virginia Department of Taxation will publish guidelines on how PTEs may make PTE elections retroactively for 2021 and 2022.
Several of the states that enacted their PTET laws in 2023 have some special retroactive election rules:
- Indiana. Elections for 2022 may be made March 31, 2022, through August 31, 2024. If the 2022 return was filed by April 18, 2023, the PTE can amend its return to make the election.
- Kentucky. Elections for 2022 may be made through August 31, 2024. The election, an amended return, and the tax payment should be made at the same time.
- Nebraska. Elections for 2018 through 2023 must be made by December 31, 2024.
- West Virginia. Elections for 2022 may be made between June 8, 2023, and September 15, 2023.
PTET Opt-Outs? Not in Most States
In almost all states, a PTET election is binding on all the PTE’s owners; individual owners cannot opt out. The only exceptions are Arizona, California, New York, and Utah.
The PTET Rate
Most states have implemented a flat PTET rate, often at the state’s top individual income-tax rate. As a result, electing into the PTET can result in more state income taxes being paid, especially in states with progressive income-tax rates.
But PTE owners still come out ahead if the federal tax savings they gain by being able to fully deduct the state PTET as a business expense exceeds the extra state income tax their PTE pays. Note that the top federal rate—37 percent—is substantially higher than the highest PTET rate: 10.9 percent, in New Jersey and New York. In most states, the PTET is between 4 percent and 6 percent.
To make their PTET tax more attractive, some states have lowered their PTET rates. The following states have reduced their PTET rates starting in 2023:
- Kentucky, from 5 percent to 4.5 percent
- North Carolina, from 4.99 percent to 4.76 percent
- Ohio, from 5 percent to 3 percent
Estimated Tax Due Dates and California Delay
PTEs that elect to pay PTET must usually pay estimated tax to the state during the tax year of the election, i.e., before the deadline for making the PTE election. In most states, the PTE must pay PTET estimated taxes on the same dates as regular estimated taxes—usually quarterly.
Uniquely, California requires a single estimated PTET payment equal to the greater of $1,000 or 50 percent of the PTE’s California PTET liability for the prior year. The payment is ordinarily due by June 15 of the year of the PTET election. However, because of storm-related postponements on tax filing and payment obligations this year, PTEs in all California counties (except Lassen and Shasta) have until October 16, 2023, to make the 2023 PTET prepayment.
How Are Non-resident PTE Owners Treated?
In many states, the PTET for resident owners is based on their pro rata share of the total income earned by the PTE, whereas for non-residents the tax is only on their apportioned share of income “sourced” to the state. In the pro rata states, PTET credits and federal deductions tend to be higher for resident PTE owners than for nonresidents.
The total-income states include Arizona, California, Colorado, Indiana, Iowa, Kansas, Kentucky, Massachusetts, Minnesota, Montana, New Jersey, North Carolina, Utah, West Virginia, and Wisconsin.
The following states do not follow this approach and apportion income for resident owners: Alabama, Connecticut, Georgia, Idaho, Illinois, Louisiana, Maryland, Michigan, New Mexico, New York, Ohio, Oklahoma, Oregon, and South Carolina.
Takeaways
States have passed the PTET to help business owners circumvent the Form 1040 $10,000 cap on deductions for state and local income and property taxes.
The $10,000 cap applies to individual taxpayers but not to businesses. The PTET taxes the pass-through income, creating a tax that the business can then deduct on its federal tax return. The state then provides a credit to the individual owner for the tax paid at the entity level.
As of now, 36 states have enacted a PTET, including seven new states during 2023: Hawaii, Indiana, Iowa, Kentucky, Montana, Nebraska, and West Virginia. PTET legislation is pending in Maine, Pennsylvania, and Vermont.
Most of the newly enacted PTET laws are retroactive. Indiana, Iowa, Kentucky, and West Virginia have made their PTET retroactive to 2022. Nebraska’s new PTET is retroactive to 2018.
Kentucky, North Carolina, and Ohio have reduced their PTET rates starting in 2023.
California’s June 15, 2023, PTET estimated tax payment has been extended to October 16, 2023.
