Pass-through entity tax (PTET), what is it, how does it work, and does it affect you?

The answer to those questions depends on where you live and whether you own or are a part of a pass-through entity.

Pass-through entities (PTE) that qualify are generally S corporations, partnerships and multi-member LLCs which are taxed as S corporations or partnerships. C corporations, single member LLCs, sole proprietorships, and trusts (in most states) are not eligible.

The PTET allows owners to work around the $10,000 state and local tax limits on their federal income tax returns. This is done by passing a credit or deduction along to them for the taxes that the PTE pays. The PTE also claims a business expense for the taxes paid on their federal return.

As of this date there are 36 states that impose income taxes that have adopted some form of PTET credit or deduction. In some cases, states have made it retroactive to as far back as 2018, check with LMHS, PC to see if your state is one of them. For most states it is an election that the PTE makes, Connecticut is the only state where it is mandatory. The due dates for these elections vary from state to state, so again check with LMHS, PC to see what the dates might be in your state. When making the election only a handful of states have opt out clauses, for all other states the election is binding on all owners of the PTE’s. States that have opt out clauses are Arizona, California, New York, and Utah.

We have selected a few states to take a closer look at their PTET and how it works.

California:

The California PTET is more commonly known as AB-150. AB-150 is calculated as 9.3% on qualified income net after tax credits for taxes paid to other states. S Corps and Partnerships are eligible, and any portion not used may be carried forward up to 5 years (but they expire after 2025). Qualified owners can opt out if they choose, and publicly traded partnerships and entities using combined reporting are not eligible.

Payments are due on June 15^th of the taxable year and must be either 50% of the elective tax paid the prior year or $1,000 whichever is greater. The second installment is due on or before the original due date of the return (3/15 for annual filers). The credit is non-refundable and can be claimed by residents, non-residents and part-year residents.

The election must be made annually, if one owner opts out the other owners only pay on their elective share of the pass-through income.

Colorado:

The Colorado PTET is called the SALT Parity Act and is effective as of January 1, 2022, and retroactive back to January 1, 2018. The credit is refundable at the owners’ level. The election is made by using a check-the-box election on the PTE’s annual return. This election applies to all the owners or members and the tax rate is 4.5%. Quarterly estimates are due in April, June, September, and December.

New York:

The New York PTET is optional for eligible partnerships or New York S corporations, they can elect to pay a certain income tax annually as of January 1, 2021. Only an authorized person may make the election for an eligible partnership or S corporation. The election cannot be made by a tax professional for their clients.

Who is not eligible to opt in: Single member LLCs (unless they elect to be treated as an S Corporation for NY purposes), sole proprietorships, trusts, non-profit corporations, corporations that are not NY S corporations.

An eligible entity may opt in on or after January1, but no later than March 15^th. Elections must be made online and cannot be revoked after the due date of the first estimated payment. All elections must be made online using the entity’s Business Online Services account, if they do not have one then the authorized person can create one.

The calculation for S corporation and partnerships is different so you may consult LMHS, P.C. for more information on this. Estimated payments made be made by either the authorized person or a tax professional, these payments need to be made online. Estimated payments are due on March 15, June 15, September 15, and December 15. Each payment should equal at least 25% of the required annual payment.

Required annual payments are the lesser of:

90% of the PTET shown on the return of the electing entity for the taxable year[1]
100% of the PTET shown on the return of the electing entity for the preceding [2]

Estimated payments cannot be made after filing the return.

Massachusetts:

The Massachusetts PTET credit is called the 63-D credit and was effective in 2021, it is calculated at 5% of qualified income. The actual credit is equal to 90% of each qualified member’s distributive share of their PTE excise paid.

Who or what is a qualifying member – Partnerships, including limited liability companies treated as partnerships for federal income tax purposes, but excluding publicly-traded partnerships; S corporations, including limited liability companies treated as S corporations for federal income tax purposes; and Trusts, to the extent that they have income that is taken into account by beneficiaries for Massachusetts personal income tax purposes.

Sole proprietorships and single member limited liability companies that are disregarded for federal income tax purposes cannot elect to be subject to the PTE Excise because they are not pass-through entities (PTEs).

Eligible PTEs must register for the 63D-ELT tax type before making a payment. They should not make a 63D-ELT payment on other pre-existing tax types.

The election is not mandatory and is made on an annual basis, once it is made it is irrevocable for that given year. Form 63D-ELT and any payments associated with it must be filed electronically through MassTaxConnect. This can also be done using a third-party software.

Guaranteed payments are included in the distributive income that a PTE reports to its members and they are included in the member’s distributive income subject to personal income tax.

A PTE must make estimated payments as follows April 15, June 15, September 15, and January 15 (the dates for fiscal year filers are adjusted based on their yearend date. These estimated payments must equal the lesser of the following:

80% of the PTE Excise ultimately determined to be due on the PTE’s current year Massachusetts Form 63D-ELT; or
100% of the PTE Excise shown on the PTE’s prior year Massachusetts Form63D-ElT, if the PTE made the PTE election for the prior year and filed a prior year return that covered a 12-month period.

If you have questions about any of these states and your eligibility or what the rules are in other states, please contact us.

[1] The source of this information is the state of New York Revenue Department website.

[2] The source of this information is the state of New York Revenue Department website.

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