Massachusetts Will Allow Residents to Claim Tax Credit for the Connecticut Pass-Through Entity Tax

Massachusetts issued a draft directive that will permit resident members of pass-through entities that pay the new Connecticut Pass-Through Entity Tax to claim a tax credit for their share of the tax paid.

By Jess Johannesen, SALT Manager

In our May 2018 SALT Newsletter, we wrote about the Connecticut Pass-Through Entity Tax (“PTE Tax”) that had been enacted as a potential workaround to the limitation on the state and local tax itemized deduction.  The PTE Tax went into effect for tax years beginning on or after Jan. 1, 2018, and it is imposed on Connecticut-source income of pass-through entities (“PTE”) at the rate of 6.99 percent.  Members of PTEs receive an income tax credit equal to 93.01 percent of their share of the amount of PTE Tax paid by such PTE.

This year, Connecticut Governor Lamont signed two pieces of legislation, HB 7424 (on June 26, 2019) and HB 7373 (on July 6, 2019), that made several changes to the PTE Tax.  On Aug. 16, 2019, the Connecticut Department of Revenue Services (“DRS”) issued Special Notice 2019(6) that details such changes, which include the following:

  • For the 2018 tax year, Connecticut will waive any late payment penalty and related interest so long as the full amount of PTE Tax due is paid within 1 year of the original due date (i.e., March 15, 2020 for calendar year filers). The DRS issued an announcement that affected pass-through entities are not required to submit any form or documentation to the state to request the waiver as the state will automatically process the waivers;
  • Effective for tax years beginning on or after Jan. 1, 2019, guaranteed payments will now be included in the calculation of income subject to the PTE Tax;
  • Effective for tax years beginning on or after Jan. 1, 2019, the PTE tax credit percentage has been reduced from 93.01 percent to 87.50 percent. In other words, a member of a PTE is now entitled to a credit of 87.50 percent of the member’s share of the PTE Tax liability; and,
  • Effective for tax years beginning on or after Jan. 1, 2019, PTEs will be able to make an annual election to remit composite income tax on behalf of its non-resident individual members in addition to any PTE Tax due.

Following Connecticut’s lead, Wisconsin, Oklahoma, Louisiana, and Rhode Island have each enacted similar pass-through entity taxes.  Other than for S-corporations in Wisconsin for which the tax is effective in 2018, these taxes (including for partnerships in Wisconsin) are applicable for the 2019 tax year.  Unlike the Connecticut PTE Tax, the tax in these states is elective (although the election may be binding for a period of time).  These states vary, however, with respect to whether members of the PTE are entitled a credit for the tax paid by the PTE or a subtraction/exclusion for the income taxed at the PTE level.

One of the issues raised by these PTE taxes is whether non-residents of a PTE will receive a personal income tax credit by their state of residence for PTE tax paid or a subtraction modification for the income that was subject to a PTE tax.  Without a credit/subtraction modification, PTE members will pay income tax on all of their income (even the income that was subject to a PTE tax).

On Sept. 19, 2019, Massachusetts issued Directive 19-1 which addresses how Massachusetts residents treat the Connecticut PTE Tax for purposes of the resident’s Massachusetts personal income taxes. Massachusetts allows individuals who are members of a PTE to claim a credit on their distributive shares of tax imposed on a PTE only if certain criteria are met.  Specifically, these criteria are:

  • the PTE must pay the tax during individual’s taxable year;
  • the tax must be measured by income earned by the entity, a distributive share of which is required to be included in the individual’s Massachusetts gross income;
  • the pass-through entity may not deduct any portion of the tax from its income in computing net income available for distribution to such member; and,
  • the tax must otherwise be allowable as a credit under Massachusetts statutes.[1]

Connecticut statutes require that the PTE Tax be deducted from an entity’s gross income in computing the member’s distributive share of net income.  Accordingly, Massachusetts’ directive concludes that, in addition to the requirements above, resident members must add back their pro rata share of PTE Tax paid by the entity when determining their distributive share income subject to tax in Massachusetts.

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.

Contact Jess Johannesen, SALT manager, at jess.johannesen@aprio.com or Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the September 2019 SALT Newsletter.

[1] See also Mass. G.L. c. 62, § 6(a); 830 CMR 62.17A.2(4)(g)2a,b, and DOR Directive (DD) 08-6.

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