Maryland Pass-Through Entities Making Entity-Level Election
August 4, 2021
At the end of June, the Comptroller of Maryland finally released its revised income tax forms to reflect the impact of recent law changes to the state’s new pass-through entity (PTE) election. The Comptroller also extended the filing and payment deadline for tax year 2020 income tax returns from PTE to September 15, 2021. A significant reason for the delay in releasing the revised forms was due to ensuring the proper reflection two income addition modifications that were enacted into law earlier this year through the RELIEF Act (Senate Bill 496) and Senate Bill 787. One of the addition modifications is at the PTE level and the other is at the member (i.e., partner/shareholder) level.
Effective July 1, 2020, the General Assembly amended TG § 10-102.1 to allow a Maryland passthrough entity to elect to pay the income tax imposed with respect to resident members’ distributive or pro rata shares of income. On February 15, 2021, Senate Bill 496 was signed into law (i.e. the RELIEF Act). The bill’s primary purpose was to relieve some of the adverse economic effects of the COVID-19 pandemic. However, the bill also made changes to the PTE tax election. Specifically, the bill expanded the scope of the election so that the entity-level tax applied to the distributive or pro rata shares of income of all members (i.e., resident and nonresident members). Thus, a PTE now has two filing options. First, a PTE can decide to not make the election, which means that the PTE will only be required to pay the non-resident withholding tax (i.e., similar to prior tax years). A non-electing PTE will file Form 510. Second, a PTE can elect to the income tax at the entity-level on the distributive or pro rata shares of income of all members. An electing PTE will file Form 511.
Pass-through Entity Addback
An electing PTE is taxed on the “pass-through entity’s taxable income.” This is the income/loss amount entered on line 2 of the new Form 511. The term “pass-through entity’s taxable income” is a specifically defined term in Maryland’s income tax law. “Pass-through entity’s taxable income” means “the portion of a pass–through entity’s income under the federal Internal Revenue Code, calculated without regard to any deduction for taxes based on net income that are imposed by any state or political subdivision of a state.” Thus, the income/loss amount to be reflect on line 2 of Form 511 is required to include an addition modification for the amount of any federal income tax deduction attributable to taxes based on net income. Additional information regarding calculating a “pass-through entity’s taxable income” can be found on page 3 of the Form 511 instructions, which are available at MarylandTaxes.Gov as well as on page 2 of the Comptroller’s revised Administrative Release No. 6 addressing the taxation of PTEs, which is available here. Both of those publications generally reflect that a “pass-through entity’s taxable income” is the net amount of income/loss for the PTE, less interest from federal obligations, plus the amount of any federal deduction attributable to taxes based on net income. We do anticipate that CCH will make the required modifications to Line 2 of Form 511. The addback for the amount of any federal deduction attributable to taxes based on net income is not unique to Maryland’s entity-level tax. I am sure everyone is familiar with having to make a similar addition modification on state C corporation returns. However, most state C corporation returns have specific lines or dedicated schedules for indicating and addition or subtraction modifications. For whatever reason, the Comptroller decided to embed the state income tax addback in the same line where net income/loss is entered. Thus, the amount of the addback will not appear on an separate line of Form 511.
For 2020, it’s important to be aware that even though the Form 511 may calculate a tax liability, some clients may not have a state income tax addback that needs to be made. This will depend on whether the particular client is a cash-basis or accrual-basis taxpayer and if the client made any PTE election payment in 2020. For example, if a client is a cash-basis taxpayer that is electing the PTE tax for 2020 and didn’t make any estimated PTE payments in 2020, then there would not be an addback required because the payment of the Maryland PTE tax was not made until 2021. The unfortunate result in this fact pattern is that there ends up being no 2020 benefit at the federal level for making the PTE election because there was no entity-level deduction. Still, presumably, the PTE would then have a very large deduction for 2021 because the PTE made the 2020 payment and the 2021 estimated payments in 2021. This is just a transitional timing issue resulting from the fact that 2020 is the first year that the PTE election exists.
Member Addback for PTE Credit
The second addback is at the member level. A member of a PTE that is electing to pay the entity level tax is required to addback to income the amount of the credit allowed on the member’s return for the taxes paid by the electing PTE. To be clear, each member of an electing PTE will receive a K-1 from the PTE that includes the member’s share of the entity-level tax paid by the PTE. The Maryland K-1 has been updated to include a line for this amount — line 2 of part D. This amount flows to the Form 500CR, Income Tax Credit for Individuals, Part CC, line 7. The credit will then be shown as a payment for the member on either the Maryland resident or nonresident income tax return. The addback for this amount is reported on line 1 of Form 500LU, and then combined with any other additions on the member’s Maryland income tax return (i.e., line 6 of Form 502 for a Maryland resident and line 20 of Form 505 for a Maryland nonresident). A similar addback is required for a corporation that is a member a PTE that has made the election to pay tax at the entity level. There is a version of Form 500LU that is specific to corporate taxpayers. The addback is included on line 7g of the Maryland corporate income tax return (Form 500).
Some taxpayer’s immediate reaction to the existence of two addbacks may be that Maryland is double taxing the same income. However, this is not the case due to Maryland’s individual income tax forms starting at a point that is based on federal adjusted gross income. Thus, the addback required at the entity-level in computing the PTE tax is not initially included in an individual’s Maryland income tax base. Thus, the addback required for an individual simply reverts the individual’s tax base on the PTE income to be inclusive of the same addback performed by the entity, as opposed to requiring an addback that is already reflected in the individual’s starting point.
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