Various states have continued the trend of implementing elective pass-through entity taxes that allow individuals some relief from the federal $10,000 limitation on deducting state and local taxes. This alert highlights southeastern states that have recently enacted legislation allowing pass-through entities to elect to be taxed at the entity level.
Enacted on February 11, 2021, Alabama House Bill 170 will allow electing pass-through entities, including S-Corporations and partnerships, to pay Alabama income tax at the entity level, effective for years beginning on or after January 1, 2021. An election must be filed with the Alabama Department of Revenue on or before the fifteenth day of the third month following the close of the tax year for which the entity is electing to be taxed, or March 15th for calendar year taxpayers. The election will remain in effect until revoked by the pass-through entity, which must submit the appropriate form to the Alabama Department of Revenue along with written consent of the owners or partners.
An electing pass-through entity shall pay tax at the highest individual marginal tax rate and will be subject to the estimated tax requirements for corporations. Electing pass-through entities will not be able to deduct any Alabama tax paid in calculating taxable income.
On May 4, 2021, Georgia enacted House Bill 149, which provides an elective entity-level tax for S-Corporations and partnerships, effective for tax years beginning on or after January 1, 2022. The annual election must be made on or before the due date for filing the applicable income tax return, including any extensions, or September 15th for calendar year taxpayers.
Electing pass-through entities will pay tax at a rate of 5.75% and not be allowed any deduction for taxes measured by gross or net income.
Effective for the 2019 tax year, Louisiana implemented an elective pass-through entity tax for S-Corporations and partnerships. Elections must be made on or before the fifteenth day of the fourth month following the close of the tax year in which the election would be effective, or April 15th for calendar year taxpayers. The election will remain in effect until terminated, which requires consent of the owners or partners and approval from the Department. Taxpayers may apply to the Department in order to terminate the election based on a material change in circumstances.
Electing pass-through entities will file Form CIFT-620. Tax will be calculated based on a series of graduated tax rates, with a maximum of 6% for Louisiana taxable income above $100,000.
The North Carolina Senate passed House Bill 334 on June 10, 2021, which includes an optional pass-through entity tax for S-Corporations and partnerships. As of the date of this alert, this bill has not been signed into law. Elliott Davis will continue to track this legislation for new developments.
On May 17, 2021, South Carolina enacted Senate Bill 627, which permits pass-through entities to elect to pay South Carolina tax on active trade or business income at the entity level. The election must be made each year on or before the due date for filing the applicable tax return, including extensions, or September 15th for calendar year taxpayers.
Active trade or business income is defined as taxable income other than passive investment income (meaning gross receipts derived from royalties, rents, dividends, interest and annuities per IRC § 1362), capital gains and losses, and personal services income. The electing pass-through entity will pay tax on active trade or business income at a rate of 3%. The qualified owner of the electing pass-through entity would then exclude their share of active trade or business income from the pass-through entity on their South Carolina tax return.
Other states that have enacted pass-through entity level taxes are as follows: Arizona, Arkansas, California, Colorado, Connecticut, Idaho, Maryland, Massachusetts, Minnesota, New Jersey, New York, Oklahoma, Rhode Island, and Wisconsin. Connecticut is unique in that the pass-through entity tax is mandatory, not elective, for all pass-through entities filing in Connecticut. In addition, the Illinois legislature recently approved a bill including a pass-through entity tax election, which is pending signature by Governor J.B. Pritzker.
Due to the varying requirements and nuances for these new filing elections, we recommend preparing a cost/benefit analysis which includes administrative considerations prior to making state pass-through entity elections. Some of the key considerations include, but are not limited to, the following:
1- What is the overall tax effect of making the election in each state?
2- What is the timing for the election? Is it an annual election?
3- What is the process for revoking the election?
4- How will the elections be included in the annual compliance for estimated tax payments and extensions?
5- Are there specific state considerations applicable to the business? (Example: only active trade or business income is included in South Carolina)
The Elliott Davis State and Local Tax Practice can assist with performing the recommended cost/benefit analysis and administrative consideration reviews for state pass-through elections. If you have questions or would like our team to perform an analysis of the available pass-through entity elections for your business, please reach out to your primary Elliott Davis point of contact or reach out to us here.
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.