Recently, Oklahoma enacted House Bill 2665 creating an optional pass-through entity-level tax that may result in a potential tax-saving opportunity for owners or individuals. A high-level summary of the tax is below. Taxpayers considering electing into the tax should make the election for the 2019 tax year no later than June 28, 2019.
Recall that the Tax Cuts and Jobs Act (TCJA) limited the individual taxpayer deduction for state and local tax (SALT) payments to $10,000 a year ($5,000 for a married person filing a separate return). SALT payments (including income and real property taxes) that exceed these amounts are no longer deductible by individual taxpayers unless the payments are in pursuit of a trade or business.
State entity-level taxes have become increasingly popular as a means to circumvent the SALT deduction limitation. The benefit of the pass-through entity paying the tax is that the ultimate partner can re-characterize a non-deductible individual state income tax expense to a deductible state income tax expense for federal income tax purposes. The taxes paid by the pass-through entity are deductible for federal income tax purposes, where the SALT limitation would apply if that tax was passed through to the member. Wisconsin and Connecticut have previously enacted entity-level taxes in the wake of tax reform.
The Oklahoma tax
To take advantage of the newly enacted tax, the pass-through entity must make an election no later than June 28, 2019, for tax years beginning in 2019. The window for making an election will not open again until Jan. 1, 2020, for the tax year 2020 and forward.
Pass-through entities eligible to make the election are those required to file an Oklahoma partnership income tax return or an Oklahoma S corporation income tax return. Individual members (owners) of an electing pass-through entity shall exclude from their Oklahoma taxable income their distributive share of Oklahoma net entity income of the electing pass-through entity on which it pays pass-through entity tax. As a result, Oklahoma state income tax paid on an electing pass-through entity’s pass-through income will be paid by an entity, not by the individual owners, and thus not subject to the $10,000 SALT deduction limit under TCJA.
The tax is calculated by aggregating each member’s tax as determined by multiplying the following: 1) each member’s Oklahoma distributive share of the electing pass-through entity; 2) the entity’s Oklahoma net entity income for the tax year; and 3) the highest state marginal individual income tax rate levied if the member is an individual, trust or estate, or six percent if the member is a corporation, pass-through entity or financial institution.
Oklahoma taxpayers considering the election must make a formal election before the deadline for the 2019 tax year. Going forward, the election must be made within two months and 15 days after the start of the tax year. The election is binding until revoked within the same period that an election must be made.
Becoming an electing pass-through entity and payment of pass-through entity tax at the entity level is elective and is not required. Not all pass-through entity members may benefit from the election and may have other tax considerations that would make the election undesirable. Other entities may benefit by converting to a pass-through entity. Taxpayers considering the election should contact their state tax advisers with questions.