Georgia Pass Through Entity Tax
February 24, 2022
At a glance
- The main takeaway: Georgia pass through entity tax is effective beginning the 2022 tax year. Georgia has joined many other states in allowing pass-through entities (PTEs), namely S corporations, partnerships and LLCs taxed as partnerships, to pay Georgia state income tax at the entity level. This legislation is intended to lessen the impact on individuals of the deduction limitation on state and local taxes enacted by the Tax Cuts and Jobs Act in 2017.
- Impact on your business: The Georgia House Bill 149 allows PTEs to elect to pay Georgia state income tax at a rate of 5.75% on the company’s Georgia-sourced net income. This will result in a reduction of each owner’s portion of income on which the tax was paid. However, the deduction will not give any credit for tax paid by the individual owner — it simply reduces the amount of income the owner is taxed on.
- Next steps: Whether a PTE should make the election to pay the entity-level tax is dependent on the facts and circumstances of both the company and its owners. In some cases, making the election to pay at the entity level may impact the owner’s ability to use income from the PTE to offset other taxes. Aprio’s Tax Team can help navigate the impact of this new tax and help your company determine whether electing to pay state tax at the PTE level will provide you with the most favorable tax outcome.
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The full story:
The passage of the 2017 Tax Cuts and Jobs Act (TCJA) included a limitation on the deductibility of state and local taxes. Under the law, individual taxpayers are only able to deduct $10,000 of state and local taxes (including state income and real property taxes) from their federal taxable income, with no carryforward provisions. This change obviously impacted taxpayers who lived in states that imposed income taxes. As a result, many of those states began looking for ways to work around the law and provide relief to their state taxpayers.
The first initiatives by states generally involved programs offering state tax credits in exchange for contributions to tax-exempt organizations. However, those contributions were disallowed by the IRS as failing to meet the standard for a charitable contribution deduction.
Eventually, states decided on the imposition of a tax on pass-through entities, specifically LLCs, partnerships and S corporations, as a means of providing relief for taxpayers with taxable business income in their states. These taxes generally allow a pass-through business with taxable activity in an affected state to elect to pay the state tax on income sourced to that state. In most cases, this results in a reduction in the amount of income that passes through to owners.
The IRS agreed to the deductibility of these pass-through entity-level taxes in Notice 2020-75, agreeing that PTEs may claim entity-level deductions for state income tax paid. Once the service was acquiesced to this deduction, more states began enacting entity-level taxes as a work-around to the deduction limits.
On May 4, 2021, Georgia enacted House Bill 149, which permits partnerships and S corporations (PTEs) to make an election to pay Georgia income tax at the entity level. The election is effective for tax years beginning January 1, 2022. The election must be made annually, on a timely filed entity income tax return (including extensions) and once an entity makes the election it cannot revoke it during that tax year. Georgia pass through entity tax rate is 5.75% and under the election the PTE will pay the current state rate.
PTEs making the election would be entitled to deduct the entity-level tax paid on their federal partnership or S corporation income tax return, which lowers the federal taxable income reported to each of the owners. This, in turn, reduces federal income tax liability paid by each of the owners. In cases where the PTE makes the election, the reduced pass-through income serves to “free up” other state and local tax deductions, which can reduce the need for individual taxpayers to make Georgia individual estimated tax payments.
The bottom line
Whether it makes sense for your pass-through business to make the election to pay tax at the entity level is dependent on the facts and circumstances surrounding your business, its owner and owners. Making the election may not always benefit all owners. In some cases, such as when an owner has Georgia losses from other activities or has Georgia tax credits carried forward from prior years, the benefit of those credits could be reduced if the PTE elects to pay the entity level tax. Further complicating matters is that not all states with PTE tax elections treat those elections the same. Some states don’t allow a credit or adjustment to resident PTE owners, which could result in owners paying additional tax owner
Aprio’s Tax Team has the knowledge and resources to help you determine whether an election to pay the PTE tax will provide you with the best possible tax results. Let us help you navigate these challenging rules.