The New York Department of Taxation and Finance has issued guidance regarding its new Pass-Through Entity Tax (PTE Tax) in the form of a Technical Memorandum, TSB-M-21(1)C,(1)I and a new webpage dedicated to the tax.
The PTE Tax was signed into law in April as part of the budget bill by former New York Gov. Andrew Cuomo, effective for tax years beginning Jan. 1, 2021. The PTE Tax was enacted in the wake of IRS Notice 2020-75, which essentially accepts the use of pass-through entities as a ‘workaround’ to the federal limitations on state and local tax deductions. The PTE Tax is optional and eligible taxpayers must decide whether the potential benefits of electing into this program outweigh the potential increased compliance costs and risks associated with PTE Tax, both for the entity and its partners. Any analysis should take into consideration the availability of credits in the partners’ or members’ home states and potential changes to the federal state and local tax limitations.
Under the newly enacted Article 24-A, 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) can make an annual election to participate in the PTE Tax. Individuals and single member limited liability companies cannot make this election. Generally, the election is required to be made by the due date of the first estimated payment (i.e., March 15th). For 2021 only, however, the election must be made no later than Oct. 15, 2021. The election, once made, is irrevocable by the taxpayer for the given tax year without approval by the state.
An electing partnership or S corporation is required to pay the PTE Tax in four equal installments on March 15, June 15, Sept. 15 and Dec. 15 during the current tax year. For the 2021 tax year, estimated tax payments are not required to be made by the electing partnerships or S corporations. Individuals, who are partners or shareholder of an electing PTE, are still required to make estimated tax payments at their level for tax year 2021 without regard to a PTE tax credit.
The pass-through entity electing into this tax regime will pay tax at a rate ranging from 6.85% to 10.90%, corresponding to the new tax bracket schedule for high-earners effective Jan. 1, 2021. Partners or members, including nonresidents, will receive a full credit for their share of taxes paid by the pass-through entity. The entity will be subject to annual certification requirements and will be required to report the partners/members share of income and credits as required by New York State.
The state also amended the credit for taxes paid provisions to expressly allow residents to claim a resident tax credit for taxes paid under “substantially similar” pass-through entity tax workaround programs imposed on partnerships and/or S corporations.
PTE Tax guidance
The guidance issued by the state includes a number of mechanical and technical issues relating to the PTE Tax. The following is a summary of the key items:
- The election must be made online using the department’s Business Online Services account by an authorized person on behalf of the partnership or S Corporation. However, the department has stated that “tax professionals may not make this election of behalf of their clients.” Taxpayers that are considering electing into this program should start the process of creating an online account if they do not already have one.
- The PTE Tax return, due by March 15, 2022 for the first year, must be filed online as well. A six month extension to file will be available online and must be filed by March 15. The PTE Tax return must contain all of the information requested by the department, including the calculation of credits available to partners.
- A fiscal-year taxpayer does not recompute its income on a calendar-year basis. The PTE taxable income must be computed for the fiscal year than ends within the PTE Tax calendar year. The due date would be on or before March 15 following the close of the calendar year in which the fiscal year ends.
- The PTE Tax payments will operate independent of other taxes. For 2021, individuals must continue to make estimated payments as if they were not entitled to the PTE Tax credit. These payments cannot be applied to the PTE Tax liabilities or vice versa. This may result in a double payment of tax for the 2021 tax year for entities that make PTE Tax payments during 2021, which will likely create a refundable overpayment for partners/shareholders. For tax years beginning on or after Jan. 1, 2022, the PTE will be required to make estimated tax payments as described above and such payments will apply only to PTE Tax liability and cannot be transferred between related entities or individuals.
- An electing partnership is required to compute its income and allocation of credits into separate pools, the nonresident PTE taxable income pool and the resident PTE taxable income pool. This is to reflect the fact that nonresident partners’ income is included in the tax base only if sourced to New York, whereas resident partners’ income is included in the tax base regardless of whether it is sourced to New York. This is in contrast to S corporations, which may only include New York sourced income in the tax base. The PTE Tax credits are also computed separately for resident and nonresident pools. The guidance provides additional details regarding this calculation. Special allocations must be taken into consideration for electing partnerships in computing each pool.
- The guidance clarifies that partners or members cannot be classified as part-year residents. If they are residents of New York for more than six months, they are treated as residents for purposes of the PTE Tax.
- An electing partnership’s calculation of the PTE Tax includes guaranteed payments.
- S corporations are required to use the apportionment rules under Article 9-A included in Tax Law Section 210-A. These rules generally apply market-based sourcing and are not applicable to partnerships or nonresident individuals.
- The PTE Tax credit will be claimed on Form IT-653, Pass-Through Entity Tax Credit. The PTE Tax credit is not applicable to corporate partners or partnerships that are partners.
- An addback is required for the amount of the PTE Tax credit claimed thereby increasing the partners/shareholders federal adjusted gross income by such amount in computing New York taxable income.
- The resident tax credit applies to “substantially similar” PTE Tax programs enacted in other jurisdictions’. The department has indicated that it will post a listing of such programs on its website. An addback is required for the amount of the other states’ PTE Tax included in the resident tax credit.
As noted above, the federal treatment of these entity-level taxes is interpreted by the IRS in Notice 2020-75. The Notice announces rules that the IRS will propose in forthcoming proposed regulations, and provides taxpayers some guidance and authority to rely on in the meantime. Neither New York nor the IRS have provided specific guidance regarding the application of the PTE Tax and the corresponding federal tax deduction with respect to investment or passive income streams. Careful consideration should be given prior to making the election, particularly with respect to the federal treatment of the PTE Tax, including timing of PTE Tax payments for tax year 2021, character and deductibility of PTE taxes paid, amongst others.
For a discussion of some related considerations, refer to our prior alert New York pass-through entity tax may benefit financial service firms.
Takeaways
New York’s guidance is helpful in providing additional detail regarding the implementation of the PTE Tax election. This program may provide a significant potential to reduce individual partner and shareholder’s federal tax liability by shifting their state tax liability to partnerships and S corporations. However, there are a number of nuances and considerations taxpayers must be aware of before electing. Pass-through entities must carefully consider whether the election will benefit the members’ federal and state tax profiles. Taxpayers with questions about the New York pass-through entity tax or other state pass-through entity workarounds should contact their state and local tax adviser.
