Deadline Quickly Approaching for Firms and S Corps To Register for Possible Tax Relief
Law firm partners and S corporation investors who were hit hard financially by the Trump Administration’s tax reforms may be able to get some relief thanks to a relatively new provision in the New York Tax Code, but the firms must act by Oct.15 to take advantage of it this year.
The Tax Cuts and Jobs Act of 2017 capped state and local tax deductions for federal income tax purposes at $10,000, creating a financial pinch for high earners in states with heavy tax burdens. States like New York quickly began looking for ways to circumvent the change.
Last November, the IRS issued Notice 2020-75 featuring guidance on how to create a pass-through entity tax system. As a result, New York instituted its pass through rules earlier this year. What that means is if firms register as pass-through entities, their partners will be able to effectively have their tax burden’s lowered through a credit.
Entities that decide to elect for the pass-through tax will be taxed at rates from 6.85% to 10.9%.
This year, firms and S corporations will have to register with the state by Oct. 15 to claim PTE status.
Linda Farrington of the New York State Department of Taxation and Finance recently told a Continuing Legal Education class hosted by the New York State Bar Association that the PTE election could take some time to complete and encouraged firms to start the process by Oct. 8.
In coming years PTE election will be due at the same time as the first estimated payment, which is March 15.
Experts on NYSBA’s CLE panel noted that there are several considerations partners should take into account before opting into the PTE process. It may initially reduce their cash flow because the PTE will likely pay at the top estimated rate while partners could have a lower personal income tax rate. Partners will see their savings in the form of a refund when they file their returns.
The New York Law Journal writes that “A direct partner or shareholder of an entity that has elected to pay the pass-through entity tax must still include in New York taxable income his share of the entity’s income (determined without any deduction for the pass-through entity tax paid). However, the partner or shareholder is allowed a refundable credit equal to his share of the tax paid by the pass-through entity.”
“One of the questions is why wouldn’t we make this election?” asked attorney Elizabeth Kessenides, who took part in NYSBA’s Sept. 27 CLE on the topic, noting that some firms may not want to elect into the PTE system.
She said that entities with New York residents and out of state residents will have to decide how and whether they want to contend with the varying rules each state has enacted. While New York plans to honor other states that follow similar rules “it’s not so clear every state will have the same rules. So, a little extra care must be taken if you have non-resident and resident members of your flow through entity,” said Kessenides.
Out-of-state partners could theoretically have their earnings taxed twice if the two states have differing positions on PTEs.
Jack Trachtenberg, principal, multistate tax services for Deloitte Tax, warned at the CLE that even if firms elect to be a PTE “the law specifically states that individual partners are not off the hook for 2021 with respect to making their estimated individual tax payments.” That will change in future years. PTEs, however, will not have to make estimated payments this year.
Another factor to consider is that partners with losses will be included in pass through entity taxable income, which could in theory reduce whatever credit is earned.
It’s also important to keep in mind that the PTE status does not apply to sole proprietorships or entities like single-member LLCs. New York-based taxpayers could consider restructuring to try to qualify for PTE status in the future.
The issue is rife with complexities and possible unexpected consequences. To get a better idea of what would benefit you and your firm most you should speak to your tax professional. For more information on considerations and scenarios pertaining to PTEs you can watch the the Sept. 27 CLE here.