Guidance on NYS Pass-Through Entity Tax
On August 25, 2021, New York State issued TSB-M-21(1)C, (1)I, which provides guidance for the optional pass-through entity tax (PTET).
As discussed in our post on June 3, 2021, New York State has created an optional pass-through entity tax which can be used as a workaround for owners of pass-through entities that are affected by the $10,000 federal limitation on the itemized deduction for state and local taxes (often referred to as the SALT cap). The optional tax is effective for tax years beginning on or after January 1, 2021.
Making the election: The election to opt into the optional tax must be made online, and the election must be done on an annual basis; each election separately applies to only one tax year, so each later tax year will stand alone and an entity can separately choose whether to elect to be subject to the pass-through entity tax for each later tax year. Once an entity makes the election for a particular tax year, the election for that tax year is irrevocable.
To make the election, an entity must use its Business Online Services account, available at: https://www.tax.ny.gov/. If an entity has not previously set up the online account with New York, it can establish the account now.
The due date for making the election for the tax year beginning on or after January 1, 2021 is October 15, 2021. For future tax years, the election must be made by March 15 of the tax year.
Computing the Tax: An entity computes the pass-through entity tax that is due by multiplying the applicable tax rate by the net total of all income, gain, loss or deduction that flows through to a direct partner, member or shareholder for New York personal income tax purposes. Note: TSB-M-21(1)C, (1)I, sets forth special rules and calculations for partnerships and LLCs that have some owners who are New York residents and some who are New York nonresidents.
The applicable tax rate is 6.85%, if the entity’s income is not over $2 million. For income over $2 million and up to $5 million, the tax rate is 9.65% of the excess. For income over $5 million and up to $25 million, the tax rate is 10.3% of the excess. For income over $25 million, the tax rate is 10.9% of the excess.
Estimated Tax Payments: For the 2021 tax year, no estimated tax payments are required for the pass-through entity tax. Beginning after 2021, the pass-through entity must pay quarterly estimated taxes equal to 90% of the pass-through entity tax for the current year or 100% of the pass-through entity tax for the prior tax year. Such estimated tax payments are due on March 15, June 15, September 15 and December 15.
Annual Tax Return: Entities that elect to pay the pass-through entity tax are required to file a new, annual tax return by March 15 that covers the prior calendar year. The return must be filed online using the online return application in the entity’s Business Online Services account.
An entity may make an online request by March 15 for a six-month extension of time to file its annual return; however, all taxes due must be paid on or before the March 15 due date.
Once the entity files a return, it may not amend the return for any reason.
Potential Savings from the Pass-Through Entity Tax: If the entity elects to be subject to the pass-through entity tax, it pays the tax to New York and can deduct this tax when computing its income for federal tax purposes. Therefore, this state tax will reduce the income reported to each owner on Schedule K-1. Thus, the owners will get the benefit of a federal deduction of the state tax that is imposed at the entity-level through the reduction of income that would otherwise be reported on Schedule K-1, and the entity-level tax escapes the $10,000 cap that otherwise applies to state and local taxes that are paid personally by owners.
On the New York personal income tax return for the owners of the entity, the entity-level tax must be added back to New York adjusted gross income, similar to way the New York State franchise tax on S corporations is currently added back to New York adjusted gross income.
However, each owner of the entity will receive a New York State income tax credit for the entity-level tax that was paid on the owner’s share of the entity’s income. As a result of this credit, the New York State personal income tax that would be due on the owner’s share of the entity’s income is offset by the entity-level tax paid by the entity to New York. Effectively, this shifts the payment of the tax from a personal tax payment (which is limited by the SALT cap) to an entity-level tax payment (which is not limited by the SALT cap). The credit will be claimed on the new Form IT-653, Pass-Through Entity Tax Credit.