On March 15, 2021, Arkansas Gov. Asa Hutchinson signed House Bill 1209, adopting an elective pass-through entity tax as a workaround to the $10,000 limitation on the federal state and local tax (SALT) deduction. The election is effective for tax years beginning on or after Jan. 1, 2022.
The Arkansas elective pass-through entity tax
Beginning in 2022, pass-through entities may elect to be taxed at the entity level. Qualifying entities include general and limited partnerships, limited liability companies or S corporations. The election must be made annually by a majority of the members with voting rights.
The tax is imposed at a flat 5.9% rate on the net taxable income of the entity, a rate identical to the state’s current highest individual tax rate, but lower than the 6.2% corporate tax rate. Entities that have a net capital gain are subject to half the tax rate on the gain. If the tax results in a net operating loss, the entity may carry forward the loss in the same manner as provided by the state’s general net operating loss rules. Additionally, any income tax credit earned under the income tax statutes may be applied to the tax liability of the entity.
Estimated payments are required. For reporting purposes, electing pass-through entities must annually report each member’s pro rata share of the tax imposed on the entity to the member and report the member’s pro rata interest in the entity to the Arkansas Department of Finance and Administration. The member’s interest is excluded from the member’s Arkansas gross income. Members may also exclude the pro rata share of income subject to a similar tax by another state. Further, nonresident owners of an electing pass-through entity are not required to file an individual tax return to the extent it represents their only source of Arkansas income.
The new Arkansas law is similar to those enacted in seven other states: Alabama, Connecticut, Louisiana, New Jersey, Oklahoma, Rhode Island and Wisconsin. Connecticut’s version of the workaround is the only mandatory tax, while the other states are elective. Other SALT deduction workarounds are pending in a number of state legislatures with a few more likely to pass this year. Importantly, not all pass-through entity members may benefit from the election. Taxpayers are cautioned that the workaround is not a panacea to the SALT deduction limitation and any federal savings may be offset by increased state liabilities.
Importantly, taxpayers should analyze whether making the election and paying the entity-level tax will result in a lower overall tax burden. Taxpayers are encouraged to contact their state and local adviser to discuss the Arkansas and other state SALT deduction limitation workarounds.