New York pass-through entity tax
Considerations for pass-through entity legislation
New York’s pass-through entity tax (PET) imposes an income tax directly on the pass-through entity as opposed to the partners, members, or shareholders. What should you consider when deciding whether or not to elect into the New York PET regime?
History of pass-through entity tax regimes
The Internal Revenue Code (IRC) allows individual taxpayers who itemize their deductions to claim a federal income tax deduction for state and local taxes (SALT) paid.1 Prior to the Tax Cuts and Jobs Act (P.L. 115-97) (TCJA), there was no limitation on the deduction, meaning taxpayers could deduct all their SALT payments paid during the calendar year to the extent of their federal taxable income.2 TCJA limited an individual’s aggregate deduction for tax years 2018 through 2025 (the SALT cap or SALT limitation).3 As a result, SALT payments in excess of the SALT cap are not deductible on the federal income tax return, Form 1040, and thus provide no benefit to an affected taxpayer. Notably, the SALT limitation does not apply to real and personal property taxes paid or accrued in carrying on a trade or business or certain other activities relating to expenses for the production of income.4
Many states contemplated workarounds to the SALT cap to protect resident individuals from a potential increase in federal tax resulting from the limitation. The most prevalent of these is the PET, which imposes a state and local income tax directly on the pass-through entity (PTE) as opposed to the partners, members, or shareholders.
On November 9, 2020, the IRS issued Notice 2020-75 that announced an intention to issue proposed regulations to clarify that state and local income taxes imposed on and paid by a partnership or S corporation on its income are allowed as an entity-level deduction in computing non-separately stated taxable income or loss for the taxable year of payment.5 This notice prompted a wave of PET legislation across multiple states.
Understanding New York’s pass-through entity tax
The NYPET is effective for tax years beginning on or after January 1, 2021, for eligible entities that are required to file a New York return.7 Entities opting to participate in the NYPET regime must make an annual election online, by March 15 of the tax year, at the same time that the first-quarter estimated payment is due.8 The election to opt into the NYPET must be made by an authorized person on behalf of the eligible entity through the entity’s Online Business Services account.9 Once made, the NYPET election is irrevocable as to the tax year for which the election was made and is effective for all eligible partners.10
To elect or not to elect?
As with many new tax regimes, the NYPET is rife with issues that need to be analyzed and further clarified. The following are a few issues to consider in New York and discuss with your tax adviser before electing:
- Group filing impact: At the time of this writing, it is unknown whether the Department will need to consider whether to allow PTEs that make a PET election to transfer group return estimated tax payments to withholding payments for the partners, or establish a mechanism for those payments to be refunded.
- Non-resident issues: It is important to understand your partner base and the potential varying impact an election may have on one partner versus another. For partnerships with individual New York non-resident partners, it will be critical to analyze each partner’s resident tax credit rules to determine whether electing into the NYPET would result in a net benefit or detriment for the individual partners.
- Income or loss issue: Another PET consideration arises where one partner is in an income posture while the other is in losses. As enacted, the NYPET is based on the partnership’s aggregated taxable income, and not the individual partner’s, meaning the NYPET taxable base is calculated net of any losses. This creates the potential that the NYPET credit that the individual income partner receives from the PTE will be less than the individual’s New York personal income tax liability.
- A resident trust issue: The NYPET is applicable to all Article 22 taxpayers subject to personal income tax, including individuals, estates, and trusts. Electing into the NYPET may present an issue for New York exempt resident trusts that are partners in the electing partnerships and otherwise have no New York–sourced income.11
References
1 See generally IRC § 164(a).
2 Note, however, that the deduction will not be considered for purposes of determining an individual’s alternative minimum tax unless the SALT deduction is allowable in computing adjusted gross income under IRC § 62. See IRC § 56(b)(1)(A)(ii).
3 IRC § 164(b)(B) (“the aggregate amount of taxes taken into account… for any taxable year shall not exceed $10,000 ($5,000 in the case of a married individual filing a separate return)”).
4 IRC § 164(b)(6)(B) (referring to taxes described in IRC § 164(a)(1) (real property taxes) and (a)(2) (personal property taxes)).
5 IRS Notice 2020-75, 2020-49 IRB 1453.
6 These include Alabama, Arizona, Arkansas, California, Colorado, Connecticut, Georgia, Idaho, Illinois, Louisiana, Maryland, Minnesota, New Jersey, New York, Oklahoma, Oregon, Rhode Island, South Carolina, and Wisconsin. As of the same date, Massachusetts, Michigan, North Carolina, and Pennsylvania have proposed PET legislation. This is in addition to jurisdictions that already impose entity-level taxes, such as the District of Columbia, New Hampshire, New York City, Tennessee, and Texas.
7 New York Tax Law § 861; New York Tax Law § 860; eligible entities generally include partnerships, limited liability companies treated as partnerships for federal income tax purposes, and New York S corporations (including limited liability companies treated as S corporations for federal income tax purposes that make the New York S corporation election). Entities may be required to file in New York where doing business in New York or having a resident partner within the state.
8 New York Tax Law § 861(c); TSB-M-21(1)C, (1)I.
9 Ibid.
10 Ibid.
11 Pursuant to New York Tax Law § 605(b)(3)(D), a New York resident trust will be exempt from tax under Article 22 where all trustees are domiciled in a state other than New York the entire corpus of the trusts, including real and tangible property; is located outside the state of New York; and all income and gains of the trust are derived from or connected with sources outside of the state of New York, determined as if the trust were a non-resident trust. See also Mercantile-Safe Deposit and Trust Company v Murphy, 19 AD2d 765, aff’d 15 NY2d 579 (July 30, 1963). Because S corporations are only subject to NYPET on New York–sourced income, and New York–sourced income will disqualify an exempt resident trust from exempt status, there would not be a NYPET electing S corporation with exempt resident trust members.
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Todd Hyman
Partner, Deloitte Tax LLP
Greg Bergmann
Partner, Deloitte Tax LLP
Jack Trachtenberg
Principal, Deloitte Tax LLP
Doran Gittelman
Manager, Deloitte Tax LLP
Alyssa Keim
Manager, Deloitte Tax LLP
