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

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.

Why the need for SALT deduction workarounds?

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.

How does the New York State PTET work?

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:

If the PTE taxable income is: then the PTET due is:
$2 million or less
6.85% of PTE taxable income.
greater than $2 million but less than or equal to $5 million
$137,000 plus 9.65% of the excess of PTE taxable income greater than $2 million.
greater than $5 million but less than or equal to $25 million
$426,500 plus 10.30% of the excess of PTE taxable income greater than $5 million.
Greater than $25 million
$2,486,500 plus 10.90% of the excess of PTE taxable income greater than $25 million.

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.

What entities are eligible?

Entities taxable as partnerships or New York State S corporations are eligible for the PTET.

These include:

  • Partnerships, excluding publicly traded partnerships.
  • Limited liability companies (LLCs) that opt for treatment as partnerships for tax purposes, excluding single-member LLCs.
  • New York State S corporations.
  • LLCs that opt for treatment as S corporations for tax purposes and whose shareholders are solely individuals.

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.

If the entity is: Authorized persons include
a New York S corporation
any officer, manager, or shareholder of the New York S corporation who is authorized under the law of the state where the corporation is incorporated or under the S corporation’s organizational documents to make the election and who represents to having that authorization under penalty of perjury.
a partnership
any member, partner, owner, or other individual with authority to bind the entity or sign returns under Tax Law § 653.

How is the election made?

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.

What are the advantages of the PTET?

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.

Staying up to date:

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.

In closing…

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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