One of the most controversial individual income tax changes enacted under the Tax Cuts and Jobs Act of 2017 is the $10,000 cap on the deduction for state and local income and property taxes (“SALT”) for federal income tax purposes. Because this SALT deduction limitation does not apply to entities, several states have enacted a pass-through entity tax on partnerships, S corporations or limited liability companies taxed as either which imposes the SALT at the entity level. The consequences are that the taxes become a fully deductible business expense for federal income tax purposes and reduce the taxable income passed through to the owners. In November 2020, the IRS issued guidance confirming that the SALT imposed and paid at the pass-through entity level is fully deductible in computing the entity’s federal taxable income or loss for the tax year of the payment.
Massachusetts became one of the most recent states to enact a pass-through entity tax (“PTE Tax”) when the Massachusetts legislature overrode the governor’s veto of the PTE Tax on September 30, 2021. The Massachusetts PTE Tax permits qualified owners of partnerships, S corporations or limited liability companies taxed as either to make an election to allow these pass-through entities to pay a 5% (the Massachusetts personal income tax rate) excise tax on their Massachusetts income. The owners of the electing pass-through entity will be entitled to a refundable credit against their personal income tax equal to 90% of their share of the PTE Tax paid by the pass-through business. Because the offsetting credit does not completely offset the PTE Tax, pass-through entity owners will pay a bit more in Massachusetts income tax by making the election but should experience a net decrease in their overall federal/Massachusetts tax liability. Qualified owners include individuals, trusts and estates.
The PTE Tax is effective for tax years beginning on or after January 1, 2021 and applies until either the SALT deduction limitation is repealed or is no longer in effect (e.g., expires). The election to pay the PTE Tax is made on an annual basis and the election may not be revoked once made. The PTE Tax is payable on the pass-through entity’s original, timely filed Massachusetts information return applicable to the PTE Tax reporting entity. Still to be provided is guidance to (i) make the credit available to qualified owners with income from eligible pass-through entities that in turn have income from other eligible pass-through entities, (ii) provide rules on the application of the PTE Tax to eligible trusts and estates, and (iii) require estimated PTE Tax payments by electing pass-through entities.