​PTE Election - Long Form​​​

Included Entities

• This special tax election is applicable to S-Corporations and Partnerships. 
• In certain states, there is the potential for Irrevocable Trusts to take advantage of this election as well. 

Excluded Entities

• This strategy will not work if the entity is a single member LLC, C-Corporation, Schedule C, or Schedule E.

What is the PTE Tax (PTET) Election?

• If you think back to 2017, Under the Tax Cuts and Jobs Act of 2017 (TCJA), the federal government passed tax reform laws which limits the amount of state level Schedule A deductions at $10,000.
  • Looks at aggregate of state income tax, property tax, real estate taxes, personal property taxes, sales tax, etc. on Schedule A
  • Cap is $10,000 regardless if married or single
• Under the TCJA, PTE owners can only deduct up to $10,000 of state and local taxes (SALT) on their personal return. 
  • For example, for a PTE business owner that has an aggregate of $80,000 SALT liability that is paid at the personal tax level, that business owner will get a maximum federal deduction of $10,000. The $70,000 balance of that tax is what is called "leakage." 
  • In response, states are now allowing PTE business owners to recover some of that "leakage" via a PTET Election. 
• By filing a PTET Election, the business owner makes the deduction at the Federal level and, therefore, is not limited at the state level by a $10,000 cap SALT deduction. 
• Instead of having the PTE business owner personally pay the state income tax, the business is going to pay the business owner's portion of state taxes directly from the business. 
  • The state tax becomes a Federal deduction for the business thereby lowering the income on the business owner's K-1 because of that deduction. 
  • If the state tax payment were paid at the personal level, there is no deduction for the business level and the income from the K-1 is higher coming into the personal tax return. 

Does the IRS Allow This? 

• The IRS does allow this Federal level deduction as long as the state has enacted the laws supporting it at the state level. 
• As of June 2022, there are 29 states that have enacted PTET laws benefiting PTE business owners and more expected to enact similar laws in the near future. 

How Does this Strategy Work? 

• Governments are creating a state level tax in order to allow the PTE business owner a federal deduction which then can be offset at the personal level as a credit for what the business already paid. 
  • A business must first have positive taxable income to take the PTET Election.
  • Once the PTET Election is made by the business, the state level tax payment is shifted to the business and becomes a federal tax deduction for the business. 
• The PTE Business owner receives a Federal tax deduction on the business because of the state level tax paid by the business.
  • This results in lower income number on the business owner's K-1. 
  • The business owner will also receive a credit on the state side on the personal return for the state taxes that the business paid.
  • Resulting credits can either be refunded or carried forward, depending on the state.

Example: A Massachusetts business owner has $400,000 of S-Corp income after all the deductions.  Owner is single and they have no other deductions or income except for the $400,000 from the S-Corp K-1.  The business owner normally pays $20,000 on their personal state tax return. Using PTET Election, the business owner can pay that $20,000 state level tax at the business level and lower the K-1 income on the federal side from $400,000 to $380,000.  Shifting the state tax to the business lowers the business owner's personal Federal income tax, thereby gaining a state tax deduction that was otherwise capped out at just $10,000.  The K-1 flows through to the business owner with lower income: Business owner is paying Federal taxes on income that is less because of the state tax paid by the business The state issues a personal tax credit at a varying amount because of that election made and the $20,000 paid at the business level.

Considerations 

There is a great deal of analysis that must be done and documentation that is required to determine whether making the PTET Election is the right strategy to pursue for the business and the owner(s). 

• With each state, the laws can be very complex and usually vary from state to state. 
• Important to consider multiple owners who live in different states where one may have the PTET election and the other may not
• Irrevocable vs Revocable election states
  • Some states have irrevocable elections, meaning it cannot change once the election is made. 
  • Other states provide for revocable elections which are flexible and have a yearly election allowing the business owner(s) to decide when to opt in or out. 
• Could be especially advantageous for PTE business owners earning more than $200,000 of K-1 income  
  • Benefit at the Federal level will be more substantial.

The PTET Election is a valuable opportunity to shift the personal income tax of a PTE owner onto the business. 

It does require making the election with the state government (for those states that have enacted the law) that the business will pay the business owner(s) share of state personal income taxes at the business level. As a result, the business will receive a federal tax deduction for the state tax paid by the business, which the business owner(s) otherwise would not get if paying at the personal level. 

At the personal level, the business owner will have an offsetting state tax credit on their tax return. Using the PTET Election strategy allows business owner(s) to recover the "leakage" incurred as a result of the TCJA of 2017. 

If you have a single member LLC, C-Corp, Schedule C or Schedule E, it may be advantageous in the short-term to look into converting to an S-Corp or Partnership to be able to take advantage of this tax saving election.

The PTET election is a new an ever-changing landscape in tax law. The GO CPA team is continually monitoring tax law updates and how this is progressing across the remaining states so we can inform you of the options available in order to take advantage of this election. If you have questions about the PTET election and whether it is applicable to your pass-through entity, send our team a message in Soraban.