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.


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