July 20, 2021
What is Pass Thru Entity Taxation?
• Tax Cuts and Jobs Act (TCJA) limited the amount of state and local taxes (SALT cap) that an individual can deduct as an itemized deduction for federal income tax purposes: $10,000 for married filing jointly and $5,000 for others.
• The SALT cap limitation does not apply to “trades or businesses.” As a result, states began instituting state tax pass-thru entity taxation where taxes were paid at the entity level generally at the highest tax rates on individuals. This resulted in less flow-thru income and some states offering tax credits.
• When IRS issued Notice 2020-75 approving entity-level deductions for state income tax thereby shifting the tax burden from individual owners to the entity, many more states enacted their own state rules for pass-thru entity tax.
• The partnership and/or S corporation pays and deducts the tax on its Federal income return.
• There are differences between states but they each provide entity owners/partners an individual tax credit, reduction or exemption from tax of the pass-thru income.
• Two basic models those that impose income tax only on the electing PTE (AL, AR, LA, OK, WI) or those with pass-thru tax credits (NY, NJ, MD, RI).
• Tax benefits to individuals vary by state as well as by individual facts and circumstances.
• Questions still remain regarding the deductibility of other state credits for the resident partner.
Bloomberg Tax & Accounting