Member Article

SALT Cap Workarounds

Six states have now enacted passthrough entity-level taxes (PTE taxes) that in many cases are avowed attempts to mitigate the loss of, or at least the limitation on, state and local tax deductions by their individual owners as a result of IRC section 164(b)(6), the so-called SALT cap. Connecticut was the first, and only state so far, that imposes a mandatory PTE tax. The other five states each offer the election, the latest being New Jersey. Several PTE tax bills are pending, including in the Alabama (S.B. 250/H.B. 353), Arkansas (H.B. 1714), Maryland (S.B. 523/H.B. 129), Michigan (S.B. 1170), and Minnesota (H.F. 871) legislatures.

Louisiana

Louisiana is one of the five states with an elective PTE tax, providing PTEs (including S corporations) the option to elect to be taxed directly, as if the entity were a C corporation. The election is available for tax years beginning on or after January 1, 2019. The Louisiana Department of Revenue recently issued guidance regarding the procedures and forms that must be submitted to make the election (LAC 61:I.1001, effective January 20). The guidance provides instructions for filing tax returns after an election has been made, and the procedure for terminating an election. The Louisiana DOR began accepting elections on February 1 for tax years beginning on or after January 1, 2019.

Massachusetts

The Massachusetts DOR issued a statement indicating that its residents who are members of a PTE that pays the Connecticut PTE tax are eligible for the individual credit for tax paid to other states (often referred to as the OSTC). The statement clarifies language in footnotes 1 and 2 of the reissued Directive No. 19-1, which indicated that Massachusetts residents are eligible for the OSTC. To claim the OSTC, a Massachusetts resident must add back their pro rata share of the Connecticut PTE tax paid by the entity when determining the member’s distributive share of income taxable in Massachusetts and must report the amount added back on the member’s Massachusetts tax return accordingly.

New Jersey

As mentioned, the most recent addition to the PTE tax list is New Jersey, which enacted the Business Alternative Income Tax (BAIT), allowing PTEs to elect to pay an entity-level tax for tax years beginning on or after January 1, 2020. The BAIT provides for a full credit at the individual level against the PTE owners’ New Jersey Gross Income Tax or Corporation Business Tax (CBT) liability, in contrast to the PTE tax available in Connecticut, which limits the owners’ credit for tax paid at the entity level to 87.5 percent. Excess credits may be carried forward for up to 20 years. PTEs electing to pay the BAIT must be included in a CBT combined return unless all the PTE’s members are gross income tax taxpayers, or no entity taxable as a corporation under the CBT has an ownership interest in or the ability to control the PTE.

If the PTE is unitary with a corporate member and the member’s combined group files a New Jersey combined return, the credit may be shared among members of the unitary group and used to reduce the CBT and the temporary surtax liability of the combined group, subject to the statutory minimum tax limitations. However, the credit may not be shared if the PTE is unitary with its member but not the member’s entire unitary group. If that’s the case, the credit may only reduce the CBT and surtax liability of the member attributable to activities separate from the unitary business of the combined group.

Rhode Island

Rhode Island is also among the PTE tax crowd, and its Division of Taxation recently provided guidance on the state’s new entity-level PTE tax in an FAQ . While the required election form (Form RI-PTE) has not been released, the FAQ does provide taxpayers with additional information regarding eligibility for the PTE tax. The FAQ provides that the tax is elective annually, is calculated as a 5.99 percent tax on net income as reported on the Federal Schedules C and E, does not include any specially allocated investment income or any other types of deductions, and can only be made “for the years it benefits the owners.” Notably, this requirement is not provided for in the applicable statute.

The FAQ reminds taxpayers that electing PTEs in Rhode Island must provide their owners with a Form RI-1099E showing the amount of entity-level tax paid on behalf of each owner and must file a copy with the division. The owner, in turn, is required to report the amounts listed on Form RI-1099E on their Rhode Island personal income tax return and a copy of the Form RI-1099E must be attached thereto. The FAQ also notes that the amount by which the entity-level tax reduces the owner’s federal adjusted gross income must be added back to the taxpayer’s Rhode Island modified gross income, but once the individual’s state tax liability is determined, the individual will receive a credit for the proportionate share of the entity-level tax paid to the state by the entity.

Texas

Texas voters (finally) approved an amendment to the Texas Constitution, Proposition 4, prohibiting the imposition of an individual income tax, including a tax on an individual’s share of partnership and unincorporated association income. As a constitutional amendment, the prohibition imposes additional procedural hurdles to prevent the imposition of this tax in the future. Under prior law, a majority vote of both chambers of the state legislature was required to put the question to voters as a ballot initiative.

The complete article was originally published by Tax Notes State on April 6, 2020. To view a full pdf version of this article click here.