A controversial provision of the Tax Cuts and Jobs Act (TCJA) limited the itemized deductions related to state taxes (real property taxes plus state & local income taxes). Since its enactment, individual taxpayers have been limited to a maximum deduction of $10,000 on their federal income tax return.
A number of states responded by enacting a pass through entity (PTE) tax on S corporations and partnerships (including multi-member LLCs) to help benefit the direct owners impacted by the tax limitation. Since most states do not tax the income from a PTE (it flows out to the owners), the thought was this tax would decrease the flow through income reported on the owner’s federal income tax return. In addition, this tax would be reported as a credit on the owner’s state income tax return to offset personal state income taxes.
One of the uncertainties of having a state tax on the flow through income of a PTE was – would the IRS accept this as a deduction against the PTE income. In November 2020, the IRS issued Notice 2020-75 allowing PTEs a deduction for the state taxes imposed on their income for federal tax purposes; the Notice states that this deduction would not be limited to the $10,000 cap imposed by the TCJA.
Based upon this favorable position, New York State has created their own PTE tax effective for tax years beginning on or after January 1, 2021. Partnerships (other than publicly traded partnerships), LLCs treated as partnerships (or LLCs who have made an election to be an S corporation for federal and New York State purposes) and New York State S corporations can now elect to pay the PTE tax.
How does the New York State PTE work?
To file and pay PTE tax, the eligible partnership or S corporation must make an irrevocable annual election by the first estimated payment due date, which is March 15 of the calendar year prior to the year in which the PTE tax return is required. The election is made annually and will be effective for the current taxable year. For the 2021 tax year only, an election must be made by October 15, 2021. A fiscal year filer is required to make the election by October 15, 2021, if the fiscal year filer’s final date of the entity’s taxable year falls before the December 31, 2021, calendar year-end. The PTE tax return will be due March 15 of the following year (the 2021 return is due March 15, 2022); fiscal year taxpayers will file by March 15 following the close of the calendar year that contains the final day of the entity’s tax return.
Electing entities are required to make four equal estimated tax payments for every quarter of a calendar year. For the 2021 tax year only, no estimated taxes will be required to be made. Beginning with March 15, 2022, estimated tax payments are to be made by March 15, June 15, September 15 and December 15, regardless of whether the entity has a calendar or fiscal year-end.
A partnership’s NYS taxable income is the sum of the entity’s adjusted net income (all items of income gain, loss, or deduction) allocated to NYS to the extent included in a nonresident partner’s taxable income and adjusted net income to the extent included in a resident partner’s taxable income. Similarly, an S corporation’s NYS taxable income includes “all items of income, gain, loss, or deduction derived from or connected with New York sources to the extent they would be included in the taxable income of a shareholder subject to tax under Article 22.”
The tax is imposed at a graduated rate from 6.85% on the first $2 million of a PTE’s taxable income up to a maximum of 10.9% on taxable income in excess of $25 million.
The tax is imposed on the entity; however, each partner or shareholder would have joint and several liability for their share of the PTE tax. As such, the owners would be liable for the tax if the entity fails to make the payment.
A NYS tax credit is available for a direct partner or shareholder of an electing PTE; the credit is based on their distributive share of the PTE taxes paid by the entity. Both resident and non-resident owners may be entitled to this credit. If an individual is a partner/shareholder in multiple electing entities, his or her total credit is equal to the sum of such credits calculated separately for each entity. If the credit exceeds tax due for the taxable year, it should be treated as an overpayment, which can be credited or refunded, without interest.
Note: Any individual that is claiming a tax credit for PTE taxes paid must have a corresponding NY addback of the amount of the PTE tax deduction (while the PTE tax is deductible in computing a PTE owner’s federal taxable income, it is not allowed as a deduction in computing such owner’s NYS taxable income).
The New York legislation provides that a resident credit will be allowed for any PTE tax paid that is “substantially similar” to NYS’s PTE tax.
Please note that this is a high level summary of the PTE tax. We are currently awaiting official guidance and forms from NYS regarding the PTE tax. As more information becomes available we will update our website.