ADOR Issues Guidance on New PTE Tax Election and Consequences of Decoupling from GILTI and IRC §118(b)(2)

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At the urging of the Alabama Society of CPAs and other groups, the Alabama Department of Revenue (ADOR) recently issued preliminary guidance on (a) how the new pass-through entity (PTE) tax election interacts with the corporate estimated tax rules, and (b) what happens if a taxpayer paid Alabama income tax on its federal “GILTI” income or on the deemed income resulting from a state or local government or IDA donating land, issuing a site prep grant, etc. to a new or expanding industry. The latter is now taxable under IRC section 118(b)(2) as a result of the Tax Cuts and Jobs Act of 2017 (TCJA). As previously reported, these issues arise as a result of the enactment of Alabama Act 2021-1, passed by the legislature unanimously and with lightning speed and signed into law by Gov. Kay Ivey on February 12, and a retroactive effective date for certain sections.

The ADOR guidance was especially time-critical for those Subchapter K entities (LLCs, LLPs, etc. classified for federal and therefore Alabama income tax purposes as partnerships) and S corporations considering an initial PTE election for the 2021 tax year. That election should effectively convert the PTE into a C corporation for Alabama income tax purposes and relieves the members/partners or shareholders of liability for Alabama income tax otherwise due on their respective shares of the PTE’s net income, although the ADOR has not yet published the forms necessary to calculate the PTE’s taxable income. The first estimated tax payment is due April 15 if the calendar year PTE “anticipates making the PTE election” for 2021 and its estimated income tax liability for the year is expected to be $500 or more. The oft-asked question by CPAs was whether they could rely on the “prior year’s tax” safe harbor normally afforded C corporations under IRC section 6655 and its Alabama counterpart. Recall that the “required annual payment” generally means the lesser of 100% of the tax shown on the return for the current year or 100% of the tax shown on the return for the preceding year. But in these circumstances, there was no prior year’s tax or tax return since the PTE last year was a PTE and therefore merely filed an information return, IRS Form 1065/ADOR Form 65.

In what many tax practitioners praised as a common-sense solution, the ADOR guidance defines the safe harbor by instead directing the taxpayer to “calculate the total of lines 1 through 17 in the Alabama column on Schedule K from the PTE’s 2020 Form 65; then multiply that figure by 5%” (the maximum individual tax rate). There is a similar calculation for S corporations making the PTE tax election.

And what if the PTE pays estimated tax on April 15 but its owners later change their minds and never make (or fail to properly make) the PTE tax election? The ADOR guidance reassures us that a refund will be due, and it prescribes the proper form. For a copy of the official guidance, click here.

The preliminary ADOR guidance on GILTI and Section 118(b)(2), issued to the Alabama Society of CPAs (ASCPA) on April 5, may be a bit more controversial. As reported in our previous SALT Alert, the state legislature inserted a “no refunds” clause in connection with its decision to decouple from those federal provisions retroactively to their date of enactment as part of the TCJA, i.e., for tax years beginning after December 31, 2017. Thus, if a taxpayer subject to one of these federal provisions paid the [then] parallel Alabama income tax for 2018 and/or 2019, at first blush he or she would seem to be out of luck. However, the language in the act only bars refunds: “No refunds will be granted or paid for tax years ending before January 1, 2020 related to the provisions of this act.” 

Many tax practitioners thought the language was narrow enough so as not to preclude their clients from claiming a credit for the (now) overpaid tax or adjusting an NOL carryover, as appropriate. Not so, says Section 7 and 8 of the new guidance. “No assessments will be issued, [but] no refunds or credits will be granted, and no adjustment of any tax attributes such as Net Operating Losses can be made” (emphasis supplied).  Some tax practitioners whose clients dutifully paid Alabama income tax on these items may have advised the client that it had little choice under then existing Alabama law -- save for challenging the state impact of the TCJA provision under the Commerce Clause or Foreign Commerce Clause, etc. -- but to pay the tax, hope for passage of curative legislation, then file a refund claim within the applicable statute of limitation. We will continue to monitor developments on this issue.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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