Since the Tax Cuts and Jobs Act of 2017, taxpayers have been limited to $10,000 of state taxes they can claim as itemized deductions. This state and local tax, or SALT, limitation has caused many people to pay more federal income taxes over the last couple years. In response, states have been looking for creative ways to help their residents still claim the deduction they once enjoyed. The federal government, though, has not always been supportive of these efforts.
Earlier this year, the IRS released a notice that more or less gave the green light to states for workaround legislation that nearly 20 states have already put in place and that five others are currently working to pass.
This SALT workaround is a pass-through entity tax, or PTET, for LLCs, partnerships, and S-Corps. The way it works is instead of these business owners paying business income tax on their personal tax returns, the state assesses the tax at the entity level and the business can take a federal deduction on the business return for those taxes paid, thus lowering the federal income and tax.
States with a PTET include Alabama, Arkansas, Arizona, Colorado, Connecticut, Georgia, Idaho, Illinois, Iowa, Maryland, Michigan, Minnesota, New Jersey, New York, Oklahoma, Oregon, Rhode Island, South Carolina and Wisconsin. See the graphic below, courtesy of the AICPA:
Here is an example how it works: Company A, an S-Corp, is owned by Taxpayer Z, in Alabama. In 2021, Company A made $2 million in net income before state taxes. Without making the PTET election, Taxpayer Z would pay about $100,000 in Alabama taxes personally and only get a $10,000 itemized deduction on his personal federal return. If Company A makes the PTET election, the business would deduct the $100,000 in state tax, and the net income going to Taxpayer Z would only be $1.9 million. By making the election the taxpayer could get an addition $90,000 in federal tax deductions, which at a 37% federal tax rate would be potential tax savings of $33,000.
The PTET is generally an elective tax and the election must be made annually. All states differ in their exact rules, so reach out to your tax manager here at Antares Group if you think this may benefit you.
Zachary Collins, CPA, is a Manager with our Business & Tax Advisory Group. He can be reached at firstname.lastname@example.org.