Tax Update: New Guidance on New York’s Pass-Through Entity Tax Credit

At a glance

• The main takeaway: New York State just recently provided some additional guidance on its pass-through entity tax credit, including eligibility, election periods and estimated payments, among other areas.
• Impact on your business: It’s important to understand the key nuances of how the credit works, especially if you are an eligible partnership or S corporation.
• Next steps: Better understand the complexities of the credit and how you may be able to benefit by scheduling time with Aprio’s Tax team.

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The full story:

Hot off the press: on August 25, 2021, New York State issued a Technical Memorandum[1] that provides guidance on its pass-through entity tax.

First, let’s take a step back

On April 19, 2021, New York State’s 2021─2022 Budget Act was signed into law. The Budget Act includes a new law[2]that provides a work around to the federal law that puts a limit on individual deductions for various state and local taxes (including income tax) on an individual’s federal income tax return. The $10,000 limit[3] has impacted individual taxpayers’ federal tax liability, especially in states with high rates of state income tax. Consequently, many of those states have enacted the pass-through entity tax (PTET) credit.[4]

Here is the concept of the work-around:

• Legislate an entity-level tax specifically for a pass-through entity, such as a partnership or S corporation
• The payment of the tax by the entity is “passed through” as a deduction to its members[5]
• Because the deduction is an entity-level tax, it does not fall under the limiting federal law mentioned above
• To make the members whole for the cash paid by their entity, the states provide a tax credit to the members on their personal state income tax returns

Voila! In theory, this concept results in zero aggregate net cash out of pocket between the entity and its members and a tax deduction for the members that avoids the $10,000 limitation.

The inner workings of the laws are a bit more complex, however, and you should always keep in mind that the devil is in the details.

How the PTET credit works in New York

Here’s a breakdown of the key details surrounding the credit for those residing in New York State:

Eligibility

In this instance, “eligibility” means the pass-through entity is able to make the PTET election.

An eligible partnership includes those pass-through entities that are treated as partnerships[1] for federal and New York State income tax purposes that have a filing requirement for New York State purposes.[2]

An eligible S corporation is any New York S corporation that is subject to the New York State fixed-dollar minimum tax.[3]

Election

Similar to most of the other states that have enacted the PTET credit, the entity-level tax (PTET) is voluntary[1] and an election is required and can only be made by eligible partnerships or S corporations. The irrevocable election is made annually online[2] and must be made by an authorized person and made on or before the due date of the first mandatory estimated PTET payment, which is March 15 in the calendar year prior to the due date of filing the PTET return. For calendar 2021 only, the election must be made on or before October 15, 2021.

For calendar-year pass-through entities, the election period is the calendar year. For fiscal-year pass-through entities, the election period is the calendar year in which the entities’ fiscal year ends.

Estimated PTET payments

Payments must be made online[3], and the four equal, quarterly payments are due on March 15, June 15, September 15 and December 15 in the calendar year prior to the year in which the due date of the PTET return falls.

The requirement to make PTET estimated payments for calendar-year 2021 has been waived; however, please note that taxpayers that need to make New York individual estimated payments for 2021 cannot reduce their personal New York estimated tax payments by the expected New York PTET credit that they anticipate they will be eligible for.

Underpayment of estimated tax penalties will be applicable for PTET tax years beginning on or after January 1, 2022. Note that if the PTET election is not made for 2021, the 100% safe-harbor rule will not be available for the 2022 PTET year.

PTET return

The PTET return is separate from the pass-through entity’s income tax return (e.g., Form 1065 and Form 1120-S) and it is filed online. The annual calendar-year return is due on or before March 15 following the calendar year with which or within which the pass-through entity’s taxable year ends.

For example, a calendar-year pass-through entity whose year ends December 31, 2021, will be required to file by March 15, 2022. A fiscal-year pass-through entity whose taxable year is February 1, 2021, through January 31, 2022, will not be due March 15, 2022, but instead will be due March 15, 2023 — this is because the entity’s year-end falls within the calendar year 2022. A six-month extension to file the PTET return is available but must be requested online by March 15. Once filed, the return cannot be amended.[4]

PTE taxable income

If elected, the PTET is imposed on the aggregated PTE taxable income, which generally is all the pass-through income that flows through to the direct members of the pass-through entity who are subject to the New York personal income tax.[5] This would include guaranteed payments.[6]

Fiscal-year pass-through entities calculate their PTE taxable income for their fiscal year; it is not recomputed on a calendar-year basis. The PTE taxable income does not include that which is flowed-through to another partnership or an entity not subject to the New York personal income tax — even though, ultimately, it is taxable to a partner in the upper-tier partnership.

The calculation is different for electing partnerships and electing New York S corporations. The electing New York S corporation PTE taxable income is the taxable income from New York State sources, regardless of the member’s New York residency status. The determination of the New York source is based on corporate apportionment rules.[7]

The electing partnership, however, must first classify between New York residents and New York nonresidents. For New York residents, the PTE taxable income is all income. For New York nonresidents, the PTE taxable income is only the PTE taxable income from New York sources. Classification can only be resident or nonresident.[8] Part-year residents must be classified either as resident (i.e., a resident for at least half of the year) or nonresident (all others). For a member that is a trust, residency is based on that of the trustee, not the beneficiaries.

The PTE taxable income of the electing partnership is calculated as two separate pools — residents and nonresidents — and then aggregated.  Special allocations for the partnership must be considered, and any limitations at the member level[9] are not regarded in this calculation. The resident pool includes all items flowing through to New York resident members and the nonresident pool only includes New York source items. The tax rate applied to the calculated PTE taxable income is a graduated rate starting at 6.85% up to 10.90%.

Determining the PTET credit

The PTET return will report the total PTET and each member’s direct share of the available PTET credit. The total PTET credits reported may not exceed the total PTET paid by the electing pass-through entity. The PTET credits can only be provided to members subject to the New York personal income tax who are identified on the PTET return.

For an electing partnership, just like the PTE taxable partnership, the PTET credits are segregated into resident and nonresident pools; again, special allocations are considered.

The allocation of the PTET credits is dependent upon whether the PTE taxable incomes of the respective pools are:

1. Each more than zero
2. Only the nonresident pool is zero or less
3. Only the resident pool is zero or less

Once determined, there is a pro-rata allocation within the pools ensuring that the entire PTET credit is allocated.

Claiming the PTET credit

For eligible taxpayers, the credit is claimed on New York State Form IT-653 Pass-Through Entity Tax Credit and must be attached to a New York State personal income tax return. PTET credits from multiple pass-through entities are aggregated. An eligible taxpayer claiming the credit must include an addition modification to federal adjusted gross income or federal taxable income on the eligible taxpayer’s New York State personal income tax return in an amount equal to the PTET credit amount claimed.[10] The addition should be reported on New York State Form IT-225.

The bottom line

Want to learn more about the PTET credit and discover how the breakdown above applies to your unique situation? Please get in touch with Aprio’s expert Tax team. Click here to schedule a consultation with us today.

[1] Currently, Connecticut is the only state that mandates the entity-level tax (i.e., it is not voluntary).

[2] New York State Department of Taxation and Finance, “Pass-through entity tax (PTET),” updated August 25, 2021, https://www.tax.ny.gov/bus/ptet/, accessed August 2021.

[3] The entity must have a New York Business Online Services account created at: https://www.tax.ny.gov/online/bus.htm.

[4] New York State Technical Memorandum TSB-M-21(1)C, (1)I.

[5] Includes certain estates and trusts.

[6] New York State Technical Memorandum TSB-M-21(1)C, (1)I.

[7] Article 9-A, Tax Law section 210-A.

[8] New York State Technical Memorandum TSB-M-21(1)C, (1)I.

[9] For example: capital losses, passive activity losses and tax basis limitations.

[10] New York Tax Law section 612(b)(43); 631(a)(2).

[1] Must have a filing requirement under New York Tax Law section 658(c)(1) and includes LLCs treated as partnerships for federal income tax purposes (or a “check-the-box” S corporation) but does not include publicly traded partnerships.

[2] Under New York Tax Law section 658(c)(1).

[3] New York Tax Law section 209.

[1] TSB-M-21(1)C, (1)I

[2] New York Tax Law Article 24-A, effective for tax years beginning on or after January 1, 2021.

[3] $5,000 in the case of married filing separately status.

[4] Some examples include New York, New Jersey, Maryland, Rhode Island and Connecticut in the Northeastern part of the U.S.; and South Carolina, Georgia and Alabama in the Southeastern part of the U.S.

[5] The term “member” in this article includes partners of partnerships, members of LLCs and shareholders of S corporations.