On April 20, 2021, New York State (NYS) Governor Andrew Cuomo signed the NYS Fiscal Year 2022 Budget into law. The bill includes an elective Pass-Through Entity Tax (PTET) under new Article 24-A of the Tax Law, which gives partnerships, limited liability companies (LLC) taxed as partnerships, and S corporations (collectively, PTEs) the option to pay income taxes at the entity level for income passed through to individuals, while the individual partners, members, or shareholders of the electing entity receive a corresponding tax credit for their share of PTET paid. The new PTET is expected to result in federal income tax savings for taxpayers who are owners of an electing pass-through entity and subject to NYS personal income tax.
NYS’s PTET was designed as a workaround to the $10,000 federal limitation on the state and local tax deduction (SALT cap) imposed by the 2017 Tax Cuts and Jobs Act. The idea behind the tax structure is that if income tax is paid at the entity level, it should be fully deductible by the entity for federal income tax purposes and not limited by the SALT cap, which does not apply to business entities.
A deduction for state or local taxes paid at the PTE level reduces the amount of net income flowing through to individual partners, members, and shareholders, effectively giving them the benefit of an above-the-line deduction of state and local taxes that is not limited by the SALT cap. With the enactment of the new PTET, partners, members, and shareholders of electing partnerships, LLCs, and S corporations will essentially be allowed a deduction from federal taxable income for NYS PTE tax paid on their share of flow-through income from the PTE. This deduction was solidified by IRS Notice 2020-75, in which the IRS notified taxpayers that it would allow the deduction of state and local income taxes paid by PTEs, and that this deduction would not be taken into account when applying the SALT cap limitation to individual owners of PTEs.
The PTET applies to tax years beginning on or after January 1, 2021. PTEs must make the irrevocable election to be subject to the PTET annually by March 15 of the tax year for which the election is made. However, see below for discussion of the election and estimated payment provision applicable only to the 2021 tax year. Annual returns for calendar year filers are due by March 15 following the close of the taxable year, and annual returns for fiscal year filers are due by March 15 following the close of the calendar year that contains the final day of the entity’s taxable year. At the discretion of the Commissioner of the NY Department of Taxation and Finance, electing PTEs may apply for an extension of up to six months to file and pay the PTET. Once a PTET return has been filed by an electing PTE, it cannot be amended without authorization from the Commissioner. Furthermore, an electing pass-through entity becomes liable for payment of the PTET upon making the election.
Interestingly, the PTET provides differing tax base computations for partnerships and LLCs versus S corporations.
The PTET base of an electing partnership (or LLC taxed as a partnership) equals the sum of the partnership’s NYS source income to the extent included in the NYS taxable income of its nonresident partners, plus the partnership’s un-apportioned worldwide income to the extent included in the taxable income of its resident partners. Under NYS personal income tax rules, the partnership income of a nonresident partner is apportioned by using an evenly-weighted three-factor formula (property, payroll, and receipts) with charges for services being sourced to New York when performed by or through an office of the business located within New York. NYS residents are not entitled to apportionment of pass-through entity income and pay income tax on income from all sources.
The PTET base of an electing S corporation equals the S corporation’s NYS source income to the extent includable in the taxable income of its resident and nonresident shareholders. Under NYS personal income tax rules, the S corporation income of nonresident shareholders is apportioned using a single receipts factor formula with sourcing based on the location of the customer.
The applicable tax rates on PTE taxable income are as follows:
PTE taxable income up to $2 million – 6.85%
PTE taxable income over $2 million but under $5 million – 9.65%
PTE taxable income over $5 million but not over $25 million – 10.30%
PTE taxable income over $25 million – 10.90%
When individual partners, members, or shareholders of electing PTEs file their NYS personal income tax returns, they are entitled to a refundable tax credit in the amount of PTET paid by an electing entity on their share of taxable income. The law also provides a credit to NYS resident partners, members, and shareholders against their personal income tax for their share of any pass-through entity tax substantially similar to NYS’s PTET that is paid to another state or locality. Additionally, NYS taxpayers should add back the amount of the above-referenced PTET credits to NYS taxable income.
The law requires quarterly estimated payments of 25% of the required annual payment due by March 15, June 15, September 15, and December 15 in the calendar year prior to the due date of the annual return. The annual payment of estimated tax required to avoid penalties and interest is the lesser of: 90% of the PTET shown on the entity’s return for the taxable year; or 100% of the PTET shown on the entity’s return for the preceding taxable year.
For tax year 2021: Since the PTET takes effect this year, and the annual March 15 deadline for electing PTET treatment has already passed, the law includes special rules for 2021. An eligible pass-through entity must make the PTET election by October 15, 2021 and is not required to make payments of estimated tax. Partners, members, and shareholders of electing entities should continue to make required estimated NYS personal income tax payments for tax year 2021 only.
When filing their PTET returns, electing entities must provide: identifying information for all shareholders, partners, or members who are eligible to receive a PTET credit; the amount of taxable income and PTET allocable to each owner; and the classification of each owner as a resident or nonresident, in addition to other specific information listed in the statute. Electing PTEs with partners, members, or shareholders that are disregarded entities must identify both the disregarded entity and the ultimate owner that is eligible to receive the PTET credit.
NYS’s new PTET may be an attractive option for certain taxpayers depending on their specific facts and circumstances. One of those complicating circumstances includes whether a resident of another state that does not have a similar pass-through entity tax will grant credit for NYS PTET paid for the resident’s share of income sourced to NYS. The new law also does not address the interaction with NYS nonresident withholding/tax payment rules, in addition to composite returns. Therefore, it is imperative to discuss the different options available and developments pertaining to the new law with your tax advisor before taking any action.