What is the Pass-Through Entity Tax? (PTET)

Ever since the 2017 passage of the Tax Cuts and Jobs Act (TCJA) introduced a $10,000 cap on individual federal state and local tax (or SALT) deductions, high-tax states in the northeast and elsewhere have sought workarounds to the cap.

Most small businesses in the United States, including partnerships, S corporations, and most LLCs, operate as pass-through entities. Known as “flow-through entities,” businesses with this structure pass all income on to the owners or investors of the company. The income is then taxed once, at the owner or investor’s personal rate. This allows business owners to avoid the “double taxation” encountered by C corporations, which pay both corporate income and dividend taxes.

Previously, no limitation on SALT deductions existed, and individuals with significant state income and real estate tax expenses could deduct them in full. However, the TCJA’s $10,000 cap caused many individuals in states with high property taxes to see a significant increase in their federal income tax liabilities.

Among these states are New York and New Jersey, both of which took matters into their own hands by creating Pass-Through Entity Tax (PTET) laws. These laws allowed pass-through businesses to report income on the entity, rather than individual level, thereby avoiding the TCJA’s SALT deduction cap — a method subsequently “blessed” by the IRS with the release of Notice 2020-75.

While the first round of PTET laws did provide a viable means for pass-through businesses to circumvent the SALT cap, they were hastily crafted, imperfect, and needed improvement.

For example, New York has adjusted the effective date, election procedures, calculation of credit and deduction for certain qualifying S corporations, and other changes. Meanwhile, new amendments to the New Jersey BAIT aim to clean up aspects of the law that did not work well in practice, such as how income is calculated for the tax, as well as how overpayments are handled, and more.

We’ll start by taking a closer look at…

Updates to the NY PTET

Several separate pieces of legislation have made multiple changes to the New York PTET.

In May this year, New York Governor Kathy Hochul signed a bill extending the election due date and creating a new opportunity for certain S corporations.

Under the prior PTET law, the deadline to make a PTET election for this year was March 15th, 2022. However, as that date had already passed by the time the new legislation was introduced, taxpayers could not analyze the new provisions to determine whether or not to elect into the PTET.

Therefore, state legislators enacted subsequent legislation in a tax nexus bill, Senate Bill 9454/Assembly Bill 10506, in August to extend the deadline. The new deadline, September 15th, applies to all pass-through entities for 2022 only.

Additionally, this second bill addressed another issue that New York legislators had debated for months concerning the PTET’s effective date. Although the original NY PTET contained a retroactive effective date of January 1st, 2021, this year’s New York State budget initially outlined only a prospective effective date, in 2023, for New York City resident owners of pass-through entities. The new legislation modified the effective date to apply retroactively from January 1st, 2022.

Lastly, for 2022, New York has increased the PTET credit and federal deduction for certain qualifying S corporations.

The original New York State PTET law used separate tax bases for partnerships versus S corporations. The tax base (or the amount of income, assets, property, economic activity, etc., which is subject to taxation) for partnerships in New York includes the state resident partner’s share of total income, regardless of its source. However, the tax base heretofore included only New York State-sourced income for S corporations.

Under the new rules, a resident S corporation (meaning an S corporation with shareholders who are all New York State residents) can now include all income in the PTET tax base, regardless of its source. This provision, which is sure to be welcome news for shareholders in qualifying S corporations, is also retroactive to January 1st, 2022.

Meanwhile, across the Hudson, changes to New Jersey’s PTET laws are also

What’s new in the NJ BAIT?

New Jersey’s PTET laws work a little differently but have the same effect. The NJ BAIT program allows shareholders or partners who take the election to receive a refundable gross income tax credit, thereby helping business owners avoid the $10,000 SALT cap.

At the beginning of this year, New Jersey legislators introduced amendments to the BAIT to subject more income to the tax. By doing so, the amendments allow New Jersey individual taxpayers to reap a greater tax advantage for electing to pay the BAIT.

Some of these amendments are similar to those which have been enacted in New York. For example, the tax base for New Jersey resident partners or LLC members that are individuals, estates, or trusts will now be required to include all their income in calculating their BAIT election, rather than only income sourced in New Jersey. Much like in New York, this will lead to a larger federal tax benefit. (One caveat: Unlike in New York, this change does not apply to S corporations in New Jersey.)

The amendments also introduced bracket changes, increasing the rate on firm income over $1 million to 10.9%, thus eliminating a middle bracket of 9.12% for income between $1 and $5 million.

Finally, New Jersey legislators have sought to address some issues with the original BAIT program, such as:

  • Allowing entities that overpay BAIT to apply the overpayment to the subsequent year
  • Revising the credit mechanism to allow certain S corporations and partnerships a refundable credit which may be applied against BAIT or other liabilities
  • No longer requiring partnerships or LLCs taxed as partnerships to withhold New Jersey gross income tax on behalf of nonresident partners or members who reasonably expect to be refunded the payment due to their anticipated BAIT credit.

In both New Jersey and New York, the above changes spell good news for pass-through taxpayers, many of whom will see greater access to the SALT cap workaround and, therefore, a lighter tax burden. Of course, both the NJ BAIT and the NY PTET laws remain works-in-progress, and both are likely to continue making changes in response to trial-and-error.

If you’d like to be sure you have a complete understanding of what these changes mean for you and your business, and to maximize your tax advantage, seeking the advice and guidance of a tax professional is an excellent first step.

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