New York State recently passed legislation enacting a Pass-Through Entity Tax (PTE Tax). Similar to legislation passed by New York’s neighbor states, the PTE Tax provides certain individual taxpayers with a viable workaround to the $10,000 state and local tax deduction limitation put in place by the 2017 Tax Cuts and Jobs Act. Effective for tax years beginning on or after January 1, 2021, eligible pass-through entities that make an election will pay income tax at the entity level rather than at the individual level. Some readers may be familiar with the New York City Unincorporated Business Tax which is, in effect, a form of a pass-through entity tax.
Eligible entities include partnerships, limited liability companies (LLCs) that elect to be either taxed as partnerships or New York S corporations and New York State S corporations as long as the partners or shareholders of those entities are all individuals. Entities that are disregarded for income tax purposes (e.g., single-member LLC’s) are not eligible to make a PTE election.
An election that is to be effective for the 2021 calendar year must be made by October 15th, 2021. For years after 2021, the election must be made by March 15th of the calendar year to which the election relates (e.g., to be effective for the 2022 calendar year, the election must be made by March 15th, 2022). An authorized officer, manager or shareholder must sign the election on behalf of an S corporation. Any member, partner or owner can make the election on behalf of a partnership or LLC.
The PTE taxable income for partnerships and LLC’s that are taxed as partnerships includes all partnership income (regardless of where earned) for NYS resident partners and NYS source income derived by the entity for all non-resident partners. NYS source income is based upon the entity’s NYS allocation percentage computed by averaging the wage, property and sales factor percentages (again, similar to the way income is apportioned for NYC UBT purposes). The PTE taxable income for S corporations is NYS source income apportioned to NYS based on the corporation’s single sales factor.
The PTE entity tax is computed based on PTE income. The rates are graduated and range from 6.85% to 10.9%.
The distributive share of PTE taxable income of LLC’s and partnership’s that have disregard entities as partners who are, in turn, owned by individuals, is included in the computation of the PTE taxable income. The PTE must provide the name and ID number of the ultimate individual owner of the disregarded PTE member or partner.
For the 2021 tax year, an electing PTE is not required to make estimated payments. However, the owners cannot take into account their anticipated share of the PTE tax credit when computing their own estimated tax payments (in effect, the owners are forced to overpay their taxes and wait for a refund). For tax years after 2021, electing PTE’s must make quarterly estimated tax payments on the 15th of March, June, September and December.
The amount of PTE tax paid on behalf of a PTE owner must be added back to the net income passed through by the PTE for NYS personal income purposes.
As more states enact PTE legislation, the question arises as to whether NYS and other states will allow the PTE tax paid as a credit for “taxes paid to another jurisdiction.” NYS has taken the position that a NYS resident who is a partner/LLC member in a partnership/LLC or shareholder in a NYS S corporation doing business in another state in which the entity has also made a PTE election, can claim a credit for their share of the PTE tax paid to the other state. Although not certain, it appears that individuals living in Connecticut or New Jersey who are owners of a NYS PTE will be allowed to claim the NYS PTE tax paid as a credit against their Connecticut or New Jersey tax. Pennsylvania, however, has taken the position that partners in partnerships cannot claim a credit for an entity-level tax but S corporation shareholders can. Obviously, each state’s laws must be carefully reviewed before deciding to make any PTE election.
Partnerships and LLC’s should consider amending their operating agreements to ensure that the PTE tax paid by the entity is allocated to each partner/member consistent with the allocation of PTE income in order to avoid any unintended consequences.
At the current time, there appears to be several internal inconsistencies between various sections of the law. Hopefully, additional guidance will be forthcoming that will clarify some of the questions that may arise as practitioners begin to study and apply the law to “real life” situations. Please consult your tax advisor if you are considering making a PTE election.
Sandy Klein, CPA, is a partner at Shanholt Glassman Klein Kramer & Co., New York, N.Y.
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