States are making progress in specifying whether pass-through entities that pay taxes in other states may get resident credits, a Multistate Tax Commission official said last Tuesday.
Jennifer Stosberg, legal division counsel at the MTC, said 31 states have said whether they will allow credits if a pass-through entity pays a pass-through entity tax in another state. She spoke at the MTC's uniformity committee meeting during the commission's fall meeting, held in Little Rock, Arkansas, and online.
Pass-through entity-level taxes began to gain steam after the 2017 federal tax overhaul, which put a $10,000 cap on the federal deduction for state and local taxes paid.
Sixteen states, meanwhile, have said if they will allow resident credits if a pass-through entity pays tax for a pass-through entity owner on a composite return in another state, Stosberg said. Seven states have said whether they will allow resident credits if a pass-through entity pays tax for a pass-through entity owner through nonresident withholding in another state.
Not all states will allow credits. The MTC is still waiting to hear back from 14 states, Stosberg said.
The issue of credits for pass-through taxes to other states by entities has increasingly arisen as states have rushed to establish pass-through entity-level taxes. Once nearly unheard of, as members of pass-through entities have been traditionally taxed via the personal income tax on the income that flows down to them, taxes at the entity level began to gain steam after the 2017 federal tax overhaul. That overhaul, the Tax Cuts and Jobs Act , notably put a $10,000 cap on the federal deduction for state and local taxes paid. States immediately began searching for ways for their residents to "work around" the cap.
Most of these ways failed after the Internal Revenue Service frowned on them, but the IRS deemed entity-level taxes on pass-throughs OK. Once that occurred, states quickly began to establish them, and now about two-thirds of states have them. In general, the entity pays a state tax and then the owners of pass-through businesses may receive a federal tax deduction and either a state tax credit or an exclusion. That has led to other questions, though, such as what happens when the entity pays tax in another state, and examining that is part of a larger project by the MTC to study the state taxation of partnerships in general.
On Tuesday, MTC staff reviewed the status of the project and noted that the commission has already published a white paper on one specific issue — the state taxation of investment partnerships. It is in the process of creating a draft model act on investment partnerships and is accepting comments. It is next turning its attention to the state sourcing of partnership income.
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