The transfer entity tax: a workaround for the SALT limitation | Marcum LLP

When the Tax Cuts and Jobs Act (TCJA) was passed in 2017, it limited state and local tax deductions (SALT) for individuals to just $10,000. Businesses and individuals in states with higher tax rates, such as New York at 12.75%, have been affected by the legislation. Many states have looked for ways to circumvent the limitation and encourage individuals to do business and reside in their state. Eventually, the Transmitting Entity Tax (PTET) became the primary strategy for partnerships working around that $10,000 SALT cap.

Although the TCJA has limited the state and local tax deduction for individuals, it still allows entities such as partnerships to deduct state and local taxes. Choosing the TFWP moves the tax from the individual level to the entity, allowing the full deduction (which is ultimately passed on to the individual). Depending on the state, an investor then claims a credit for the tax paid, or their adjusted gross income is reduced by their share of income received from an elective flow-through entity (ETP).

The IRS issued Notice 2020-75 in late 2020, allowing the PTET deduction to be taken at the entity level and passed through to an investor. The notice does not clearly indicate the types of companies authorized to benefit from these deductions. If you operate a trade or business, you have the right to elect and deduct state and local taxes. The notice also does not mention whether entities such as investment partnerships that earn non-trading income qualify for these deductions. This is one of the reasons why it is essential to consult a tax advisor before making a TFW election.

Where PTET Elections Can Be Made

Below is a map that shows all of the states that currently allow a PTET election, as well as those that will allow it starting in 2022. New York City will also allow the PTET election starting January 1, 2023. The New York City pass-through entity tax is in addition to all other current taxes, including the unincorporated business tax.

Transient Entity Tax in New York

The New York State TFWP is an irrevocable annual election. For years 2022 or later, the choice must be made between January 1 and March 15. To help, New York extended the election period for 2022 until September 15. The graduated rate of the TEWP varies from 6.85% to 10.9%. The credit is only available to partners – such as individuals, estates, and trusts – subject to Section 22 tax. For any flow-through tax imposed by another state, New York will allow a tax credit for New York State personal income residents. tax.

Connecticut Transfer Entity Tax

As shown in the map above, the only mandatory tax on flow-through entities is imposed in Connecticut. The tax is levied on any partnership or S-corporation that does business in Connecticut or has income from or related to Connecticut sources. All partners in a partnership are subject to the 6.99% tax.

New Jersey Pass-Through Business Alternative Income Tax (PTE/BAIT)

The New Jersey Pass-Through Business Alternative Income Tax option is an annual option that must be completed by the tax return due date. The PTE/BAIT applies to all entities, and the partner receives a credit of 100% of the tax paid. In 2022, an electing PTE pays tax on their NJ taxable income at a graduated tax rate ranging from 5.675% to 10.9%, depending on their distribution proceeds.

Optional California Transfer Entity Tax (PTE)

The California PTE is an irrevocable annual election made on a timely filed tax return. Optional PTE Tax applies to individuals, trustees, estates, or trusts subject to California personal income tax, and disregarded entities owned by one of the former. The optional tax is 9.3% of the entity’s qualifying net income, which is the sum of the qualifying taxpayer’s income subject to California personal income tax. An eligible taxpayer can defer the non-refundable credit for up to five years.

While making a PTET choice may be in an entity’s best interest, the outcome varies widely based on status and many other variables. It is necessary to consult a tax advisor to determine the impact that the TFWP elections will ultimately have on the entity and its investors.

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