Pass-through entity tax elections

There has been a recent trend among states to enact legislation that allows for a pass-through entity (PTE) to make an election to pay tax at the entity level. This trend began after the passage of the 2017 Tax Cuts & Jobs Act (“TCJA”) which limited the State and Local Tax itemized deduction on the 1040. States, especially ones with high income tax rates, wanted to lower their taxpayer’s federal tax burden, without having to lower their actual state tax burden.

As of December 2022, 29 states and 1 locality have enacted legislation allowing pass-through entities to elect to pay tax at the entity level. Although each of these elections are somewhat different, the overall common theme is to shift the state taxation of pass-through entity business income from the owner to the entity itself. The state tax imposed on the business income at the entity level would, in theory, be deductible for federal purposes. This reduces the amount of federal taxable income that is attributed to the owner of the pass-through entity. This treatment was confirmed when the IRS released IRS Notice 2020-75 which discussed the allowance of expensing PTE tax payments.

In order to determine the overall benefit of taking these elections, each taxpayer’s specific fact pattern needs to be analyzed. This includes taking a close look at entity type, ownership structure, income type, owner residency and multi-state presence. There can be situations where taking the election increases the tax burden. Please reach out to us to see if these elections could benefit your business.

The information provided in this communication is of a general nature and should not be considered professional advice. You should not act upon the information provided without obtaining specific professional advice. The information above is subject to change.