The recently-implemented Inflation Reduction Act brought about sweeping changes impacting U.S. taxpayers. Yet, one frequently-debated provision of the tax code ended up remaining unchanged, in spite of demands from representatives of high-tax states with Pass-Through Entity Tax (PTET) laws: the SALT cap.
However, although federal legislators who supported a repeal of the SALT cap ultimately conceded on that point, key state-level changes to both the New York PTET and New Jersey’s similar Business Alternative Income Tax (BAIT) have nevertheless modified the landscape for business owners.
So, what do these recent changes to the NY/NJ PTET laws mean for pass-through taxpayers in 2022? Continue reading to discover what you need to know this year.
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…
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
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:
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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Jeff Coyle, CPA, Partner of Rosenberg Chesnov, has been with the firm since 2015. He joined the firm after 20 years of business and accounting experience where he learned the value of accurate reporting, using financial information as a basis for good business decisions and the importance of accounting for management.
He is a diligent financial professional, able to manage the details and turn them into relevant business leading information. He has a strong financial background in construction, technology, consulting services and risk management. He also knows what it takes to create organizations having built teams, grown companies and designed processes for financial analysis and reporting.
His business experience includes:
Creating and preparing financial reporting, budgeting and forecasting.
Planning and preparation of GAAP and other basis financial statements.
Providing insight on financial results and providing advice based on those results.
Jeff also has a long history of helping individuals manage their taxes and plan their finances including:
Income tax planning and strategy.
Filing quarterly and annual taxes.
General financial and planning advice.
Prior to joining the firm in 2015, Jeff was in the private sector where he held senior financial and management positions including Controller and Chief Financial Officer. He has experience across industries, including construction, technology and professional services which gives him a deep understanding of business.
Jeff graduated from Montclair State University, he is a CPA and member of the American Institute of Certified Public Accountants, New York State Society of Certified Public Accountants and New Jersey State Society of Public Accountants.
Jody H. Chesnov, CPA, Managing Partner of Rosenberg Chesnov, has been with the firm since 2004. After a career of public accounting and general management, Jody knows the value of good financials. Clarity, decision making, and strategy all start with the facts – Jody has been revealing the facts and turning them into good business results for more than three decades.
He takes a pragmatic approach to accounting, finance and business. His work has supported many companies on their path to growth, including helping them find investors, manage scaling and overcome hurdles. His experience and passion for business reach beyond accounting and he helps businesses focus on what the numbers mean organizationally, operationally and financially.
He has a particular expertise in early-stage growth companies. His strengths lie in cutting through the noise to come up with useful, out of the box, solutions that support clients in building their businesses and realizing their larger visions.
Prior to joining the firm in 2004, Jody was in the private sector where he held senior financial and management positions including General Manager, Chief Financial Officer and Controller. He has experience across industries, which gives him a deep understanding of business.
Jody graduated with a BBA in Accounting from Baruch College, he is a CPA and member of the American Institute of Certified Public Accountants and New York State Society of Certified Public Accountants.
In addition to delivering above and beyond accounting results, Jody is a member of the NYSCPA’s Emerging Tech Entrepreneurial Committee (ETEC), Private Equity and Venture Capital Committee and Family Office Committee.
He is an angel investor through the Westchester Angels, and has served as an advisor for many startup companies and as a mentor through the Founders Institute.
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