Recent Passthrough Entity Tax Credits and Other SALT Workarounds

As the calendar flipped to 2019, we’ve seen continued activity in states looking to find some way to combat the loss of SALT deduction to “help” its in-state taxpayers. The Tax Cuts & Jobs Act (“TCJA”) (P.L. 115-97) capped the individual state and local tax deduction at $10,000 per year beginning January 1, 2018, making it even harder for folks in high-tax states to stomach the payment of state and local taxes. To alleviate this burden, various states have offered up a myriad of “workarounds” usually in form of charitable contributions or new taxes designed to shift the tax burden from individuals (whose SALT deductions are capped) to businesses (which face no such cap). As we move into a New Year, let’s examine some of the recent developments.

Wisconsin’s Voluntary Entity-Level Tax

The Wisconsin Legislature passed an optional entity-level tax on the net income of passthrough entities to bypass the federal limit on the state and local tax deduction (the SALT cap). S.B. 883, an omnibus bill introduced during a lame-duck extraordinary session, was approved in the Wisconsin Assembly on a 57–27 vote after passing the Senate the night before on a party-line vote of 18 to 15. Governor Scott Walker signed this measure into law on December 14, 2018 and it because effective two days later.

The legislation provides for an election for passthrough entities, including partnerships, limited liability companies and tax-option corporations (e.g., S corporations) (collectively, PTEs) to be taxed at the entity level, with the PTE owners allowed an exclusion for the investors' distributive share of income subject to the new PTE tax. Under prior Wisconsin law, PTEs are not subject to entity-level income/franchise taxes. The PTE's income, loss and apportionment factors flow through to the owners. However, S.B. 883 amends Wisconsin statutes to allow a PTE to elect to be taxed at the entity level at the corporate tax rate of 7.9%. If a PTE elects to be taxed at the entity level, S.B. 883 also provides an income exclusion for the owners of the PTE.

The Wisconsin tax, like those in other states, is intended to benefit PTE owners who are Wisconsin residents and whose PTE income is being taxed at the top Wisconsin marginal individual rate of 7.65%. PTEs with out-of-state owners might not benefit from the election if they are not allowed a credit in their home state for the Wisconsin tax that would be paid at the entity level if the election were made. Perhaps for this reason, the tax is voluntary.

Connecticut’s Mandatory Passthrough Entity Level Tax

Last year Connecticut enacted legislation that imposes a mandatory passthrough entity-level tax on the net income of passthrough businesses and creates an offsetting individual income tax credit for the entity’s members. Retroactive from the May 31 date of passage to tax years beginning January 1, 2018, I wrote about the nuts and bolts of this entity tax here. According to the Connecticut Department of Revenue Services, a passthrough entity is now subject to a tax on its own income, known as the Pass-Through Entity Tax (or “PET” for short), instead of passing along the tax to its partners, members or shareholders, as is traditionally done with passthrough businesses. However, the law also provides a tax credit that taxpayers can claim on their state income tax returns and corporate tax returns to ensure the entity's income isn't taxed twice.

New York’s Voluntary Payroll Tax

Following a similar theme, last year New York proposed an optional entity-level tax, but it is very complicated and has drawn some criticism. As explained in an article in the Wall Street Journal December 3, here’s how the program lets New Yorkers circumvent the deductibility cap: Employers can opt to impose a levy, starting at 1.5% next year but rising to 5% by 2021, on employee wages over $40,000. They would likely reduce or hold down employee wages by the same amount.

According to the article, employees would be granted a credit against their state income-tax liability equal to the amount charged in the payroll tax. The taxpayer’s pretax income would decline, but they would see lower federal taxes and greater after-tax income.

In the recent WSJ article, a state official said that only 220 businesses had opted into the plan as of November 30, 2018, a figure representing less than 0.1% of the state’s employers and an unknown number of employees. Not shocking, from my perspective. Nobody likes new taxes, even if they are designed to “help!”

New York/New Jersey’s Optional Passthrough Legislation

The New Jersey Senate passed legislation to create an optional passthrough entity tax with an offsetting refundable income tax credit.  Amended S. 3246 cleared the Senate December 17 on a 40–0 vote. The measure was introduced December 3 by Sens. Paul Sarlo (D), Troy Singleton (D), Steven Oroho (R), and Anthony R. Bucco (R) and is meant to circumvent the new $10,000 limit on the state and local tax deduction under the federal Tax Cuts and Jobs Act. Identical bill, A. 4807, was introduced in the General Assembly December 10 by Assembly members Daniel Benson (D) and Anthony M. Bucco (R). The measure has not yet been scheduled for a vote. 

Under the bill, which was drafted with input from the New Jersey Society of Certified Public Accountants, the refundable gross income tax credit could be claimed by members of a passthrough entity that “elects to owe and pay the passthrough business alternative income tax.” The bill defines a passthrough member as a shareholder of a New Jersey S corporation; a partner in a general, limited, or limited liability partnership; or a member of a New Jersey limited liability company. 

The Senate Budget and Appropriations Committee on December 10 amended S. 3246 to change the tax rate on passthroughs from a flat rate of 10.75 percent to a graduated rate structure of 5.25 percent on passthrough entities with income under $250,000; 6.37 percent for income under $1 million but at least $250,000; 8.97 percent for income under $3 million but at least $1 million; and 10.75 percent for income of $3 million and over.

Note that New York has proposed a similar entity-level tax, called the “Unincorporated Business Tax” (UBT), but unlike the payroll tax measure, this tax would not be voluntary. As the New York Legislature gets back in session this year, we’ll soon find out if New York joins Connecticut and adds this new tax on the books.

Stay Tuned

On a federal level, Congress did not address the SALT Cap as part of its modified year-end tax package. However, just this week, a bill was put forward in Congress (and a bipartisan one at that!) to get rid of the SALT cap. Check back here for continued developments!

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