Potential Tax Savings for Members, Shareholders, and Partners of Pass-Through Entities

On August 25, 2021 the New York State Department of Taxation and Finance issued Technical Memorandum TSB-M-21(1)C, (1) (TSB-M-21(1)C, (1)I:(8/25):Pass-Through Entity Tax (ny.gov)) addressing the pass-through entity tax (PTET) under new Tax Law Article 24-A1, which is an optional tax that partnerships or New York S corporations may annually elect to pay on certain income for tax years beginning on or after January 1, 2021.

If a partnership or New York S corporation elects to pay PTET, partners, members, or shareholders of an electing partnership or New York S corporation (“electing entity”) who are subject to tax under Article 22 may be eligible for a PTET credit on their New York State income tax returns. The intent of this new tax is to allow small business owners to deduct income taxes associated with their income from Pass-through Entities, such as partnerships and S-Corporations, without limits imposed under the Tax Cut and Jobs Act signed into law by President Trump.

The SALT deduction limit is already scheduled to expire under current law after 2025 (effective for tax years beginning on or after January 1, 2026). Democrats in Congress have been pushing to eliminate or modify the deduction limit, but President Biden did not include a provision addressing the SALT deduction limit in his Fiscal Year 2022 budget.

Sole proprietors are not eligible to elect the PTET, but may consider establishing an S-Corporation to take advantage of this workaround. A cost-benefit analysis to compare the additional costs to the potential savings is recommended, including that the SALT deduction limit may be revoked.

Pass-through entities operating in multiple states should also perform an analysis to determine if there is a benefit for them.

IRS Notice 2020-75, n-20-75.pdf (irs.gov), states that the IRS intends to issue proposed regulations clarifying that state and local income taxes imposed on and paid by a partnership or an S corporation are allowed as a deduction by that entity in computing its taxable income or loss in the year of payment. The notice also clarifies that the rule applies in a tax year ending after Dec. 31, 2017, covering the period back to implementation of the state and local tax deduction limit.