On May 31, 2018, Connecticut Governor Dannel Malloy signed Senate Bill 11, the state’s tax reform package and response to recent the Tax Cuts and Jobs Act (Pub. L. No. 115-97, commonly known as the “TCJA” and enacted on Dec. 22, 2017).
The state tax reform package seeks to provide two avenues to mitigate the impact of the $10,000 state and local tax (SALT) deduction cap for individual taxpayers by providing for the (1) imposition of a new entity level tax on pass-through entities and (2) tax credits to taxpayers making contributions to “community supporting organizations.”
The highlights of Senate Bill 11 include the following:
- Imposition of a 6.99 percent entity level income tax on pass-through entities with a credit to offset partner level taxes
- Provision of an offsetting property tax credit to eligible taxpayer’s making voluntary contributions to an approved “community supporting organizations”
- Presumption of expenses related to dividend received deduction to be five percent of dividends received
- Decoupling from section 168(k) and section 163(j)
Pass-through entity tax
The tax will be imposed at a rate of 6.99 percent on pass-through entities (PTE), including S-corporations, partnerships and LLCs treated as partnerships. PTEs will be allowed to file on a combined basis with one or more commonly owned PTEs. For purposes of multi-tier partnership structures, lower-tier PTEs would be required to subtract distributive income or add distributive loss of upper tier entities when calculating taxable income. The taxable income will be based on either the PTE’s Connecticut Source Income or the elected alternative base. Equal quarterly payments for the tax will be due on the 15th day of the fourth, sixth, ninth and first month of the preceding year. Any resulting income (e.g., individual) tax liability will be offset by a Connecticut income tax credit distributed to the partners, owners, or shareholders. The credit will be equal to 93.01 percent of the owner’s distributive share of the PTE tax.
NOTE: Connecticut’s existing mandatory composite tax regime would be repealed with a nonresident individual not being required to file a Connecticut personal income return if their only Connecticut income was from a PTE subject to the tax.
Property tax credit
The state’s tax reform package provides for a residential property tax credit up to the value of voluntary donations made to a “community supporting organization” in the owner’s municipality of residence. The credit may not exceed the lesser of (1) the property tax owed or (2) 85 percent of the taxpayer’s donations. To be entitled to and claim the credit, the taxpayer would be required to submit an application to the tax collector of the municipality where the residential property is located.
NOTE: Connecticut is one of only a handful of states that have enacted similar legislation in response to federal tax reform. The IRS has indicated that it intends to provide regulations regarding the deductibility of state and local tax payments which could eliminate the applicability of such a credit. For more information, please read our alert, IRS announces proposed regulations on SALT deduction cap.
Expense addback for dividend received deduction
Disallowance of the deduction for expenses related to a dividend received deduction is amended to enumerate that the disallowed dividend equals five percent of all dividends received during the year. This provision will be effective for tax year 2017.
NOTE: Currently, no provision exists for a taxpayer to petition to use actual expenses.
Depreciation and asset expensing
Senate Bill 11 decouples from the bonus depreciation provisions of section 168(k) provided by the TCJA. Specifically, for tax years beginning on or after Jan. 1, 2017 and property placed in service after Sept. 27, 2017, individuals receiving income from a PTE would be disallowed from taking additional depreciation under section 168(k) in arriving at federal adjusted gross income. However, partners (individuals) can apply 25 percent of the depreciation add-back as a subtraction over four years. Similarly, individuals and corporations would be required to apportion the federal deduction for qualifying section 179 property over five years.
Expense interest limitation
Senate Bill 11 decouples from section 163(j). This effectively eliminates the applicability of expense interest limitation in calculating Connecticut income under the prior section 163(j) or new section 163(j) limitations.
The state’s tax reform package represents an ardent response to what has been perceived as a northeast bias as it relates to the state and local tax deduction by the state. Moreover, due to the imposition of the new entity level tax regime on PTEs and provision of property tax credit mechanism, taxpayers should carefully review the bill and understand that further regulatory action and departmental guidance related to tax reform will be forth coming regarding these matters by both the Connecticut Department of Revenue Services as well as the IRS.
For more information on federal and state tax reform, please see RSM’s Tax Reform Resource Center.