Hawaii, Montana and Nebraska Enact Elective Pass-through Entity Taxes
July 26, 2023
By: Michael Colavito, SALT Director
At a glance
- The main takeaway: Hawaii, Montana and Nebraska join the long list of states enacting pass-through entity taxes (PTET).
- Assess the impact: While every state PTET shares the same goal, taxpayers and practitioners need to be aware of the nuances in how each state’s PTET operates, eligibility criteria and impacts on owners.
- Take the next step: Aprio’s State and Local Tax (SALT) team can assist PTEs and their owners with understanding their eligibility and the tax implications of state PTET elections to maximize benefits from these new taxes.
The full story:
As promised in last month’s SALT Newsletter article summarizing new elective PTETs enacted in Iowa, Kentucky, and West Virginia, this month’s article focuses on new PTETs in Hawaii, Montana and Nebraska.
As a reminder, state PTETs are intended to provide a workaround to the $10,000 limit on the federal deduction for state and local taxes as enacted by the Tax Cuts and Jobs Act (TCJA) of 2017. This is accomplished by allowing a pass-through entity (PTE), which typically includes entities treated as a partnership or S corporation for federal income tax purposes, to elect to pay income tax at the entity level. As permitted in IRS Notice 2020-75, the PTE is entitled to deduct the PTET paid on its federal return, which lowers the net income of the PTE that flows-through to owners of the PTE. Generally, the state then provides owners of the PTE a tax credit or income exclusion to account for the PTET paid at the entity level.
Highlights of the new PTET regimes in Hawaii, Montana and Nebraska
The newly-implemented PTETs in Hawaii, Montana and Nebraska serve as excellent reminders that although state PTETs all share the same goal, there are many differences in how state PTETs operate with respect to the PTE and its owners.
- The PTET applies to taxable years beginning on or after January 1, 2023.
- The election is made annually (guidance on the due date has not yet been provided), is irrevocable once made and is binding on all the partners, shareholders and members of the pass-through entity.
- The tax base for Hawaii’s PTET includes each member’s (excluding corporate members) distributive share of net income of the PTET and guaranteed payments of Hawaii taxable income. Although not directly addressed in the legislation, it appears that Hawaii’s PTET is based on an unapportioned tax base for income attributable to resident owners and an apportioned tax base for the income attributable to nonresident owners.
- The Hawaii PTET is imposed at the highest marginal income tax rate for individual taxpayers, which is currently 11%.
- A member of an electing PTE is allowed to claim a credit against their Hawaii income tax equal to the member’s share of the PTET. However, Hawaii’s PTET credit is nonrefundable, and the bill does not address if excess PTET credits may be carried forward to subsequent tax years.
Montana Governor Greg Gianforte signed Senate Bill 554 into law on May 19, 2023. The key aspects of Montana’s PTET are summarized below:
- The PTET is effective for tax years beginning on or after January 1, 2023.
- The election is made annually by the due date of the entity’s return (including applicable extensions) and is irrevocable once made. Guidance issued by the Department of Revenue indicates that the PTET return will be Form PTE.
- Montana’s PTE election applies to the distributive share income of owners that are individuals, estates, trusts and pass-through entities. The Department’s guidance clarifies that the distributive share income attributable to C corporations and tax-exempt entities is not subject to the PTET.
- The PTET is calculated on each owner’s distributive share of income apportioned or allocated to Montana. However, an entity may elect to have the distributive share of Montana resident owners to be tax on their entire distributive share of income (i.e., an unapportioned tax base), which will provide a greater tax benefit. In addition, the legislation specifically states that a PTE that has one or more resident owners is permitted to elect and pay the PTET even if the PTE has no business activity in Montana.
- The tax is imposed at the highest marginal individual income tax rate for the applicable tax year — 6.75% for tax year 2023 and then reduced to 5.9% in 2024.
- Owners of an electing PTE are permitted to claim a refundable credit against their Montana income tax liability equal to their share of the PTET paid by the electing PTE.
Nebraska’s PTET legislation (LB 754) was signed into law by Governor Jim Pillen on May 31, 2023. The relevant rules reflected in the legislation are summarized below:
- For taxable years beginning on January 1, 2018, but before January 1, 2023, a PTE (i.e., a partnership or S corporation) can make a retroactive election to pay income tax at the entity level. The retroactive election for these tax years must be made prior to January 1, 2025. The deadline for an electing PTE owner to file a claim for a credit or refund is extended to the later of the existing statute of limitations or January 31, 2026. The legislation requires the Tax Commissioner to publish additional guidance and/or forms for implementing the retroactive election process.
- For taxable years beginning on or after January 1, 2023, the PTET election is made annually, is irrevocable once made and is due on or before the due date for filing the applicable return, including any granted extensions.
- The Nebraska PTET is calculated based on the elective PTE’s income that is allocated and apportioned to Nebraska.
- The tax is imposed at the highest marginal individual income tax rate for the applicable tax year — 6.64% for tax year 2023 and 5.84% for tax year 2024. This legislation also provides income tax rate reductions each succeeding year until the top rate hits 3.99% in 2027.
- Owners of an electing PTE are allowed to claim a refundable credit against their Nebraska income tax liability equal to their share of the Nebraska PTET paid by the electing PTE.
The bottom line
Taxpayers and practitioners need to be aware of the nuances of each state’s PTET system as the rules regarding the election itself, the years for which the election is available, the income base upon which the tax is imposed and the refundability of credits to PTE owners varies from state to state.
At the time this article was published, only four states (Maine, North Dakota, Pennsylvania and Vermont) and the District of Columbia do not have a PTET. The remaining states either have a PTET or do not impose an individual income tax.
Aprio’s SALT team can assist PTEs and their owners with understanding the tax implications of state PTET elections to maximize the benefits from these new tax systems. We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.
This article was featured in the July 2023 SALT newsletter.
Stay informed with Aprio.
Get industry news and leading insights delivered straight to your inbox.
About the Author
Michael assists clients with a broad range of state and local tax issues. His expertise extends to many areas of multistate taxation, including income, franchise, sales and use, and property taxes. Michael’s experience also includes representing clients at all stages of tax controversy—from audit through appellate litigation as well as advising clients on restructurings and state tax refund and planning opportunities.