Executive summary: Indiana adopts pass-through entity election
On Feb. 22, 2023, Indiana Gov. Eric Holcomb signed Senate Bill 2 adopting an elective pass-through entity level tax as a workaround to the $10,000 limitation on the federal deduction for state and local taxes. The measure passed both the house and senate unopposed. Indiana becomes the 30th state to adopt such an election which was both requested and ultimately anticipated by the business community.
Indiana continues wave of pass-through entity election workarounds
The election, tax and credit
The pass-through entity election permits partnerships and S corporations to elect annually to pay the entity-level tax at the current individual tax rate, or 3.23% for 2022 and 3.15% for 2023. The law is also retroactively effective for taxable years beginning on or after Jan. 1, 2022. Partners and shareholders are allowed a refundable credit against their Indiana income tax for their distributive share of the entity-level tax. The election is not available to C corporations, trusts, sole proprietorships or limited liability companies taxed as C corporations for federal purposes.
Elections and estimated payments for 2022 and 2023
The election for tax year 2022 must be made after March 31, 2023, and before Aug. 31, 2024. The election for tax year 2023 and after must be made during the taxable year, or after the taxable year on the entity’s timely filed return, including any extensions. The election is irrevocable for the year the election is made.
An electing entity is not required to make estimated tax payments for tax years ending on or before June 30, 2023. For taxable years ending after June 30, 2023, and on or before Dec. 31, 2024, an electing entity must make estimated tax payments for the taxable year on or before the end of the taxable year. There is no penalty for underpayment of estimated tax unless it fails to equal to or exceeds 50% of the tax due. For tax years ending after Dec. 31, 2024, there is no underpayment penalty for estimated tax except to the extent the payments paid fails to equal or exceed the lesser of 80% of the tax due or 100% of the tax due in the preceding taxable year.
Miscellaneous provisions of the election
The new election permits a credit for “substantially similar” pass-through entity taxes paid to another state. Additionally, nonresidents are generally considered to have filed a return in the state when the nonresident only derived income from sources within Indiana includible in the distributive share income from an electing pass-through entity.
With a 3.15% tax rate for 2023, the entity-level tax is imposed at the same rate as the Indiana individual income tax. Several taxpayer-friendly features of the law are worth noting. First, the law is retroactively effective for 2022 tax years, providing an extra year for eligible pass-through entities. Second, the law grants a credit for taxes paid to other states. Finally, the law allows nonresidents whose only income is from the electing entity to not file an income tax return when the entity paid the tax.
Indiana becomes the 30th state to adopt a pass-through entity election in addition to New York City. Other states that have proposed or are considering an election in 2023 state sessions include Hawaii, Iowa, Kentucky, Vermont and West Virginia.
Indiana pass-through entities considering electing into the new tax are cautioned that not all owners may benefit from such an election. As in other states that have adopted the workaround tax, making the election may, or may not, create significant tax savings when aggregating federal and state tax liabilities and the various tax considerations of the owners or shareholders. Please contact your Indiana state and local tax adviser for more information on the new election. For more information on state pass-through entity elections generally, please consider reading our article on what you need to know for state pass-through entity tax elections.