UPDATE: Can a New York Resident Claim a Resident Tax Credit for the Connecticut Pass-through Entity Tax? New Legislation Provides An Answer

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Hodgson Russ LLP

In the blog I posted below, more than a year ago, we tried to answer what has been a pressing question about how far New York’s resident credit rules go, and specifically whether NY resident who pays the Connecticut pass-through entity tax (or really any other state’s PTE tax) could claim a resident tax credit in New York for such taxes. Sixteen months later, there still is no direct answer to this question, though I continue to believe there’s some authority under existing law to claim such a credit.  But earlier this week, as part of the Governor’s 2021 Budget Proposal and buried in provisions around a new PTS tax for New York (which we will cover in a separate blog post, don’t worry), there’s this amendment to Tax Law § 620: 

“A resident shall be allowed a credit against the tax otherwise due pursuant to this article for any pass- through entity tax substantially similar to the tax imposed pursuant to article twenty-four-A of this chapter [the new tax law section for New York’s new PTE tax] imposed on the income of a partnership or S corporation of which the resident is a partner, member or shareholder for the taxable year by another state of the United States, a political subdivision of such state, or the District of Columbia upon income both derived therefrom and subject to tax under this article.” 

So there you have it.  The catch?  It does not tax effect until 2022, when New York’s pass-through tax also becomes effective! So New Yorkers are still left to wonder whether credits were or could be legally taken for PTE taxes paid between 2018-2021. 

Original post - September 23, 2019

Last week the Massachusetts Department of Revenue released a Directive (Directive 19-1) announcing its position that its residents can claim a credit for the taxes paid by pass-through entities under Connecticut’s PET, the Connecticut workaround to the federal cap on state and local tax deductions. Practitioners with New York clients have been asking the same question, but the New York Tax Department has not, up to this point, provided any similar guidance.

So what do we think from this corner? Again, the question is whether a New York resident can claim a resident tax credit under Tax Law § 620 for the portion of the PET tax paid on its behalf.

Under Tax Law § 620(a), a resident is allowed a credit “for any income tax imposed for the taxable year by another state of the United States . . . upon income both derived therefrom and subject to tax under this article.”  The language of the statute, interestingly enough, does not specifically indicate that the tax has to be paid directly by the individual taxpayer. Moreover, there is a specific provision under Tax Law § 620(d) relative to S-corporation shareholders making clear that the term “income tax” under subsection (a) of Tax Law § 620 “shall not include any such tax imposed upon or payable by the corporation.”  So from one perspective, it would appear that if the law under 620(a) prohibited the application of a credit for an entity-level tax, this S corporation carve-out would not be needed. Thus, since Tax Law § 620(a) does not specifically require the tax to be paid by the individual taxpayer, a reasonable conclusion can be reached that an entity level income tax paid by a partnership or a limited liability company is creditable under Tax Law § 620. 

Unfortunately, as noted above, there are no official Tax Department publications or tax return instructions providing this guidance. One reason for this could be that there is some concern that taking such a public position might actually undermine what Connecticut is trying to do and therefore cause more harm than good. For instance, as we noted in our November 2018 article on the PET tax, if a partner is allowed a resident credit for the tax paid in her home state by the pass-through entity, does this give the IRS more basis to claim that the “tax” here was really on the partner, not the entity? For now, as has been reported, the IRS’s silence on the issue is leading some to conclude that it won’t attack these types of passthrough-entity-tax workarounds in the same way they attached the charitable-deduction workarounds.

For what it’s worth, I did speak with a Tax Department official about this and was told that the Tax Department has not taken a formal position on this issue. However, it has been providing informal guidance to taxpayers who have asked the question. That guidance is as follows: “if you believe that the taxpayer is entitled to a credit, the credit can be taken on the return and an explanation should be included disclosing the position.” Something like this probably works for a statement:

The taxpayer is claiming a credit of $____for income taxes paid to the state of Connecticut on its behalf by [INSERT NAME OF ENTITY].  Because this Connecticut tax was paid by the entity upon an income both derived from Connecticut and income that is subject to tax under this article, the taxpayer believes a credit is allowable under Tax Law § 620.” 

Given the Tax Department’s ambivalence on this issue, I would guess that the Tax Department will not be actively seeking to deny credits claimed by taxpayers for the Connecticut pass-through entity tax, at least for taxes paid by partnerships or LLCs. That said, because of the specific carve-out for S-corporation shareholders in Tax Law §620 (d), it is less likely that an S-corporation shareholder would be able to claim credit for the pass-through entity tax paid by the corporation. Still, and again given the Department’s relative silence on the issue, even S- corporation shareholders could consider taking the approach above, i.e., to claim the resident credit but include a statement with the return disclosing the position.

Of course, none of this constitutes any sort of binding, legal advice….probably best for you to not get that from a blog!

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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