States Continue to Move Toward Allowing PTE Tax Elections

Every month we add more and more states to the list of jurisdictions allowing taxation of pass-through entities (such as partnerships and S corporations) at the entity level rather than the individual level. The purpose of this election is to provide a workaround to the federal $10,000 cap on individual state and local tax deductions.

You can find a nifty map of the 36 US states that have jumped onto this bandwagon so far, along with links to the relevant state websites by clicking here.

Here are the latest state updates:

Arizona has updated the calculation for partnerships that elect to be taxed at the entity level. Beginning in tax year 2023, the taxable income of a partnership that elects to be taxed at the entity level will include the tax modifications for distributive income passed through to the partners, in addition to any other items that otherwise determine the taxable income of a partnership.

Iowa has enacted an entity-level tax election for pass-through entities that allows a partner or shareholder to claim a credit against the individual and franchise taxes paid retroactive to January 1 2022.

Taxpayers have to make a separate election for each tax year. The election is irrevocable once made and is binding on the taxpayer and all partners or shareholders. Publicly traded partnerships are not allowed to make the election. A taxpayer making an election will be subject to the maximum personal income tax rate. A refundable credit is available to pass-through entity owners on their distributive share of the pass-through entity tax (PTET) paid. Taxpayers making the election must make estimated payments of tax if the amount of tax, less credits, can reasonably be expected to be more than $1,000 for the tax year. An electing PTET is not required to make estimated tax payments for a tax year beginning prior to the effective date of the law.

Michigan’s flow-through tax rate has been reduced to 4.05% for tax years beginning in 2023. This is due to a reduction in the personal income tax rate.

Montana has joined a growing number of states that have enacted an optional PTET as a workaround to the federal $10,000 cap on individual state and local tax deductions. Eligible entities (a partnership or S corporation) can make the election for tax years beginning in 2023.

Eligible entities are required to make the PTET election annually no later than the due date, including extensions, of the pass-through entity return, currently March 15. Once the election is made it is irrevocable for that year.  The PTET rate is equal to the highest marginal tax rate, currently 6.75%.  Electing entities are required to make quarterly estimated tax payments and will incur interest on any underpayments of tax. A refundable credit is available to pass-through entity owners on their distributive share of the PTET paid. 

Nebraska has enacted a PTET workaround to the federal $10,000 cap on state and local tax deductions. An eligible entity is a partnership, and any entity treated as a partnership for federal income tax purposes (except publicly traded partnerships), including a limited liability company, and an S corporation. 

Eligible entities can make an annual irrevocable election to be taxed at the entity level retroactive to January 1, 2018 for the taxable period covered by the return. For elections for tax years starting on or after January 1, 2023 the election is made on or before the due date for the applicable income tax return (including any granted extension time). The PTET rate is set at the highest individual income tax rate imposed for the tax year of the election. For tax years beginning on and after January 1, 2024, eligible entities must make estimated tax payments as if they were a corporation. Changes to past tax returns are permitted only when directly related to the PTET election. A partnership may pay tax on an amended return as if it were an individual and would require a partnership making the election to also pay the tax, penalties, or interest due.  A refundable credit is available to pass-through entity owners on their distributive share of the PTET paid. 

State Tax Changes Affecting Businesses

Alabama

Alabama Jobs Act incentives have been extended from July 31, 2023, to July 31, 2028, and the annual credit cap has been increased from $350 million per year to an additional $25 million each year from 2023 to 2027. An incentivized company may be granted transferability of the investment credit for up to the first five years (previously the first three years). Enhanced Jobs Act incentives are provided for projects located in a “targeted county”, defined as any Alabama county with a population of 60,000 or less (previously 50,000 or less).

Colorado

Effective July 1, 2023, retailers with retail sales of $500,000 or less in the previous calendar year can receive an exemption from the retail delivery fee (RDF). In addition, retailers can elect to pay the RDF on behalf of a purchaser.

Indiana

• The calculation of the net operating loss (NOL) deduction has been clarified and updated as of January 1, 2023.
• Successors are liable for certain unpaid taxes following a business asset sale, including sales tax, use tax, and any county innkeeper tax or food and beverage tax.
• The Department of State Revenue is authorized to publish or disclose the status of a sales tax exemption certificate.

Tennessee

• The calculation of the apportionment formula has been updated as of December 31, 2023.
• For tax years 2024 and 2025, the state will provide a family leave credit equal to the federal credit to the extent the federal credit was based on Tennessee paid compensation.
• Tax credits earned in tax years ending after 2008 may be carried forward for 25 rather than 15 years.
• A sales tax holiday has been set for food and food ingredients sold between August 1, 2023 and October 31, 2023.
• The state has adopted new sales tax sourcing rules effective July 1, 2024.
• Effective May 11, 2023, individuals with less than $100,000 of receipts within a county or incorporated municipality are exempt from the tax and licensing provisions and the county tax. This threshold was previously $10,000.

State Tax Changes Affecting Individuals

Arizona

• A one-time individual income tax Arizona Families Tax Rebate will be issued to Arizona taxpayers who filed a full year resident tax return for tax year 2021, claimed a dependent tax credit, and meets certain other criteria. The rebate amount will be $100 or $250 depending on the age of the dependents.
• The amount of unreimbursed adoption expenses for 2023 through 2025 that can be subtracted from individual income taxes has been increased from $3,000 to $40,000.

Georgia

• Effective January 1, 2024, the standard deductions are increased:

1. Married filing jointly from $7,100 to $24,000
2. Single/Head of Household from $5,400 to $12,000
3. Married filing separately from $3,550 to $12,000

• Effective January 1, 2024, only a $3,000 exemption for each dependent will be allowed, with all other personal exemptions eliminated.
• Effective January 1, 2024, taxpayers who itemize will be able to take a $300 credit against the income tax, not to exceed the taxpayer’s income tax liability. This credit may not be carried forward or be applied to previous year’s liabilities.
• Effective January 1, 2024, a tax is imposed on the retail purchase or retail sale of specified digital products, goods, or codes sold to an end user in Georgia. There is an exemption for subscription products. However, internet access service is exempt from sales and use tax.

Indiana

• Individual tax rates for 2024-2028 have been reduced from the current 3.15% as follows:

1. 2024 – 3.05%
2. 2025 – 3%
3. 2026 – 2.95%
4. 2027 – 2.9%

• Taxpayers who make contributions to an approved affordable housing organization can claim a nonrefundable tax credit equal to 50% of the amount donated, up to $20,000.
• Beginning January 1, 2023, a taxpayer can claim a $3,000 dependent child exemption in the first year the taxpayer is able to claim the exemption for the child (up from the current $1,500 exemption per dependent child).
• Effective January 1, 2024, compensation earned by a nonresident of Indiana for employment duties performed in the state for 30 days or less during a calendar year is exempt from the state’s AGI tax. This does not apply for compensation earned by professional athletes, entertainers, or public figures.
• Indiana counties can impose a local income tax rate to pay for county staff expenses of the state judicial system in the county, not to exceed .2%.

Changes to State Tax Provisions for Student Loan Debt

California – Certain COVID-19 pandemic related student loan debt and grants are excluded from state taxable gross income:

• Between 2022 and 2026, unpaid fees due or owed by a student to a community college which was discharged pursuant to COVID-19 emergency appropriations for education provisions of the California Education Code is excluded from gross income.
• Between 2020 and 2027, certain emergency financial aid grants received by a student in postsecondary education are excluded from gross income.

Maryland – For tax years after December 31, 2022, the state has increased the amount of tax credits available for any taxable year available from $9 million to $18 million. Half of this amount is reserved for state employees with the other half available for other qualified taxpayers using specific criteria. More information is available by clicking here.

States Updating Conformity with the Internal Revenue Code

As you know, tax laws change all the time, and state tax law doesn’t always conform to federal tax laws. Some states adopt the entire Internal Revenue Code (IRC), and some states just adopt certain portions. Some states adopt the IRC as it existed as of a certain date, so if that date is earlier than the current tax year, federal and state laws will differ more significantly. State conformity to the IRC can have a significant impact on the amount of taxes paid, so it’s important for taxpayers to understand the conformity rules in the states in which they live and work.

This month, these states have updated their IRC conformity rules:

California – For taxable years beginning on or after January 1, 2021 and before January 1, 2026, California conforms to the amendments made by Section 9675(a) of the American Rescue Plan (ARPA) to IRC Section 108(f)(5).

Georgia – For taxable years beginning on or after January 1, 2022, Georgia adopts the provisions of all federal tax acts as they relate to the computation of Federal AGI or federal taxable income for corporations that were enacted on or before January 1, 2023.

Indiana – Retroactive to January 1, 2023, references to the IRC are updated to mean the Internal Revenue Code of 1986 as amended and in effect on January 1, 2023. Previously, Indiana’s conformity date was March 31, 2021.

Tennessee – Taxpayers may take bonus depreciation deductions for assets purchased on or after January 1, 2023, for Tennessee excise tax purposes, in the year of the purchase if the taxpayer takes bonus depreciation on the asset for federal tax purposes. For assets purchased on or before December 31, 2022, bonus depreciation deductions continue to be disallowed.

South Carolina – the state’s conformity to the IRC is updated through December 31, 2022.

For more about State and Local Tax visit MizeCPAs.com