Navigating through the world of state and local tax

State and local tax planning seems to be in a never-ending world of flux. As soon as one issue appears to be somewhat settled, another area of complexity comes into being. Two such areas, pass-through entity tax elections and the Supreme Court’s Wayfair decision are cases in point. With the $10,000 cap on the state and local tax (SALT) deduction enacted as part of the Tax Cuts and Jobs Act of 2017 (TCJA), more and more states have enacted workarounds in an effort to circumvent the limitation. On the other hand, Wayfair was decided four years ago, with many believing the issue of economic nexus for sales tax purposes appeared to be settled. However, the Multistate Tax Commission (MTC) revised its Statement of Information Concerning Practices of Multistate Tax Commission and Signatory States, calling into question how broadly Wayfair and P.L. 86-272 can be applied to the taxation of different internet transactions.

Pass-through entity tax elections — state-side

During 2022, approximately 12 additional states enacted a pass-through entity tax (PTET) election which brings the total number of states to 29 plus New York City. As a reminder, the PTET elections are in response to the SALT deduction limitation which was enacted under the TCJA legislation. Currently, individual taxpayers are only allowed a maximum deduction of $10,000 on federal Schedule A for all state taxes paid.

The following states (and New York City) currently have a PTET election: Alabama, Arizona, Arkansas, California, Colorado, Connecticut, Georgia, Idaho, Illinois, Kansas, Louisiana, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, New Jersey, New Mexico, New York, North Carolina, Ohio, Oklahoma, Oregon, Rhode Island, South Carolina, Utah, Virginia and Wisconsin.

The PTET allows the entity to pay state taxes and deduct them for federal income tax purposes thus reducing the overall federal tax liability. However, the formula is not as simplistic on the state side of these elections. Careful analysis of owners’ tax attributes, the mechanics of calculating the PTET liability and limitations for taking credit for other state taxes paid, including the PTET as well as other implications to the owners’ state income tax filings, must be completed. When owners of a pass-through entity are residents of different states, the outcome of these elections can produce both winners and losers, meaning some may pay more tax while others less. How an entity resolves the tax differences that may occur among its owners with these elections needs to be addressed proactively. Careful consideration should also be given to S corporations; an unintended consequence of these elections could result in a second class of stock thus invalidating the federal S corporation election. Partnership agreements should be reviewed to ensure they address the tax differences that can result between its partners.