For owners of pass-through entities (PTEs), much of the year-end tax guidance from 2021 will apply in 2022 as well. However, there are some recently enacted PTE tax workarounds worthy of discussion.
Beginning with tax year 2018, the Tax Cut and Jobs Act (TCJA) limited taxpayers’ personal income tax deductions to no more than $10,000 of total state and local taxes (SALT). In late 2020, the Internal Revenue Service (IRS) approved one key workaround to the SALT deduction limit: owners of PTEs are allowed to pay a separate business entity tax at the state level, as opposed to a withholding or paying related tax that would be subject to that SALT deduction limit.
Currently, 29 states and New York City have enacted a PTE tax. Legislation is pending in three states (Iowa, Pennsylvania, and Vermont) and nine states do not impose an individual income tax. That leaves nine states that have not proposed any legislation to enact a PTE tax.
While every state might have the same goal in mind when enacting a PTE tax, two things became very obvious during the 2021 tax season: Rules will continue to vary by state, and deadlines to claim a PTE election are firm.
It is important to understand the mechanics of the PTE election in different states and to stay on top of varying state laws. Some states made changes just days before the PTE tax filing deadline. In some instances, the PTE election is easy to make: taxpayers simply check the box on the tax return. Other states may require taxpayers to file a separate PTE tax return and/or make the election on the state’s website.
In 2022, Colorado enacted a retroactive PTE election, making its PTE election effective back to 1/1/2018. Virginia enacted a PTE tax that was initially effective 1/1/2022, then 1/1/2021, but it did not issue any guidance on how to make the election for 2021. New York City became the first city to enact a PTE tax, effective January 1, 2022.
Unless a federal law is enacted, the PTE tax workaround is here to stay. It is something to embrace as you determine the impact to your business and you as an owner. There is no one-size-fits-all solution when making a PTE election, so you should carefully analyze your options.
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