New York recently passed the Pass-Through Entity Tax, which allows some business owners to pay tax at the business level. If you own a business, this may enable you to avoid the $10,000 limit on state and local tax deduction on Form 1040, Schedule A, that was imposed by the Tax Cuts and Jobs Act (TCJA) in 2017.
However, to take advantage of this new rule, you must elect to pay your tax this way.
The deadline for this election (only in 2021) is the 15th of October, so it is coming up quickly.
Since New York State only enacted this new provision in April 2021 and has modified it since it is likely that partners, members, or shareholders of entities may still have questions, such as:
This post will answer these questions and help you determine if it is beneficial for your entity to elect to pay the New York State Pass-Through Entity Tax.
New York’s Pass-Through Entity Tax is an optional tax that certain partnerships or New York S corporations may elect to pay on certain income. Outlined in Article 24 A, the PTET became law as part of the state’s 2021-2022 budget. It is effective for tax years beginning on or after the 1st of January, 2021.
The PTET functions as a workaround to the state and local tax (SALT) itemized deduction cap created under the Tax Cuts and Jobs Act (TCJA). This cap, effective for tax years 2018 through 2025, limits individual SALT deductions each year to $10,000.
New York is not the first state to enact such a workaround. Some states, such as Virginia, Maryland, and Ohio, have already taxed pass-through entities. After the passage of the TCJA, states such as Connecticut and New Jersey also adopted elective PTET provisions. And since then, many other states have followed suit.
But an open question remained: would the IRS approve of these tactics?
In November of 2020, the IRS weighed in on the issue with the release of Notice 2020-75, announcing that Pass-Through Entity Taxes would be deductible at the entity level, and therefore not subject to the TCJA’s $10,000 limitation.
With this favorable IRS position effectively “blessing” PTET workarounds, New York State finally joined the list of states passing such laws in April 2021.
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..
The 2017 passage of the TCJA imposed that $10,000 cap on individual SALT deductions.
The result of this change? Many individuals in high-tax states, like New York, saw a significant increase in their federal income tax liabilities.
So, businesses began to seek workarounds to minimize their tax burden.
Here is the catch: the TCJA SALT cap does not apply to entity-level state tax liabilities.
So, by allowing shareholders or partners to report pass-through income on the entity, instead of individual-level, PTET laws let businesses avoid the $10,000 cap.
Essentially you pay the tax and get the deduction at the entity level before receiving the income on a personal level.
New York’s Pass-Through Entity Tax rates are the same as the state’s current personal income tax rates, based on the entity’s income. The determination of the rates works as follows:
Beginning in 2022, electing pass-through entities will need to make quarterly estimated tax payments on the 15th of March, June, September, and December.
For the 2021 tax year, however, these payments are not required.
Instead, individual owners will need to pay estimated taxes and claim a refundable credit against their New York State income tax returns.
Entities taxable as partnerships or New York State S corporations are eligible for the PTET.
Only authorized persons may make the election on behalf of an eligible entity, which means tax professionals may not make this election on behalf of their clients.
You must make the election annually, by the date of the first estimated tax payments. As previously discussed, that date will be the 15th of March, beginning in 2022, but is the 15th of October for this year only.
The only way to make the election, at this time, is online through the Department of Taxation and Finance’s website. The authorized person will need to create a Business Online Services account and sign in electronically.
Once made, the election is irrevocable for the remainder of that tax year. This means that you cannot reverse it or change your mind—so make sure you are certain before taking this step.
For 2022 and after, authorized persons may make the election between the 1st of January and the deadline, the 15th of March.
For eligible entities, the most apparent advantage of the PTET is the ability to circumvent the $10,000 SALT deduction cap.
Additionally, the tax is not subject to the Alternative Minimum Tax (AMT). The AMT, which applies in addition to regular income tax for certain individuals, estates, and trusts, is designed to limit tax benefits available to taxpayers with high economic income. The AMT was often imposed on SALT deductions in the past, but this is not the case for the PTET.
Finally, the PTET also allows New York residents a tax credit against their personal income tax due for all other “substantially similar” pass-through entity taxes paid in other states.
Recently, the New York State Department of Taxation and Finance clarified details of the state’s new Pass-Through Entity Tax (PTET).
The guidance issued on the 25th of August, 2021, came in the form of a Technical Services Memo. The memo, TSB-M-21(1)C, (1), provides information, examples, and access to the online form to make the election.
Check this document for more details and updates.
Electing into the New York State Pass-Through Entity Tax can offer significant tax savings and other benefits. However, there are other important considerations for shareholders and partners to keep in mind.
For 2021 only, electing into the PTET can cause cash flow issues as individuals await refunds for their estimated tax payments this year. Furthermore, New York City taxes are not eligible for the PTET.
When considering whether or not to elect into the New York State PTET, you should carefully weigh your specific circumstances to determine if it will benefit you. You are not required to take any action until the deadline, but October 15th will be here before you know it.
Now is the time to start giving some serious thought to the Pass-Through Entity Tax.
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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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