New York’s fiscal year 2023 budget bill that was enacted into law significantly expands the benefits of the state’s pass-through entity tax (“PTET”) for many businesses. Some of the major PTET highlights include amplifying the benefits for resident S corporation shareholders, as well as establishing a New York City PTET. The budget bill, which was signed into law on April 9, 2022, also accelerates individual income tax rate reductions, adds new or modifies some existing tax credits, among other provision changes.
Many states across the nation have enacted electable PTETs in an effort to provide businesses a workaround to the federal state and local tax (“SALT”) deduction limitation that the Tax Cuts and Jobs Act (“TCJA”) put in place. As these PTETs are generally revenue neutral to a state, but at a cost to the federal government, many states are racing each other to expand the benefits of their PTET. For context, in January 2022, New Jersey revised its PTET, resulting in it being more uniform with New York’s PTET. Now, with the recent New York legislative changes, with careful consideration, the state’s PTET could potentially be more advantageous for certain businesses.
New York PTET S Corporation Update
The New York PTET allows partnership (including LLCs) and S corporation entities to make an annual election to pay an entity-level tax. Prior to this legislation, the tax base for S corporations included only income derived from New York sources. Meanwhile, for partnership entities, the tax base includes all income of a resident partner and New York sourced income of a non-resident partner.
Under the budget bill, effective for tax years beginning on or after January 1, 2022, electing S corporations now include a new category of S corporations for purposes of the PTET, known as “electing resident S corporation”. An “electing resident S corporation” is required to certify that all its shareholders are residents of New York. If the certification requirements are met, then the electing resident S corporation will be able to include all income (sourced and unsourced) as part of its calculation to determine its PTET taxable base. This would put an S corporation on similar footing to a partnership entity regardless of its sourced income. Any S corporation that cannot satisfy this certification requirement, would still use the former rule in computing its taxable base, limited to New York sourced income.
Establishing a PTET for New York City
Also tucked within the budget bill, effective for tax years beginning on or after January 1, 2023, a separate and distinct New York City PTET election will also be offered.
Eligible entities include:
- Partnerships that have a least one partner or member that is a New York City resident individual; or
- S corporation that ONLY has New York City resident individual shareholders.
The tax base for all electing entity types includes all income of a New York resident owner. The tax rate of the New York City PTET is a flat rate of 3.876%. A full credit similar to the New York PTET is available on the owner level to offset against their personal income tax. As a final note, the New York City PTET is on top of, but does not replace the New York City Unincorporated Business Tax (“UBT”) imposed on partnerships or General Corporation Tax (“GCT”) imposed on S corporations.
PTET Income Tax Addback
Unlike for federal purposes, New York disallows a deduction of pass-through entity tax for personal income tax purposes. The budget legislation amends the statute to clarify that PTETs are added back only once. Although there was some uncertainty, this amendment will help clear up the state’s guidance that no addback would be required for the pass-through entity, only at the individual owner level for the amount of distributive share of the PTET credit, resulting in no duplication of state tax addback.
Other Budget Bill Highlights
In addition to the PTET changes, some of the other key highlights to the budget bill includes:
- Accelerates the phase-in of income tax reductions that was previously scheduled to take effect in 2025:
- Beginning after 2022, the tax rate for married filing jointly for income between $27,900 and $161,550 is 5.5% (was 5.73%), and for income between $161,551 and $323,200 the rate is 6% (was 6.17%).
- Expansion, extension, or modification of a number of credits/exemptions, including: Investment Tax Credit for Farmers; Farm Workforce Retention Credit; NYC Musical & Theatrical Production Credit; Hire-a-Vet Credit; Low Income Housing Credit; Clean Heating Fuel Credit; Transportation for Persons with Disabilities Credit; Empire State Film Production and Post-Production Credit; Youth Jobs Program Credit; Empire State Apprenticeship Credit; Alternative Fuels and Electric Vehicle Recharging Property Credit; Earned Income Tax Credit, among others.
- Increases the small business subtraction modification and expands the modification to include owners of limited liability companies, partnerships, and New York S corporations.
- During the state of emergency (but not to extend beyond December 31, 2021) employees obligated to work outside of New York during COVID-19 still count as New York employees for certain tax credit and incentive programs.
- Creates a new property tax relief credit, the Homeowner Tax Rebate Credit, for eligible low and middle-income households, as well as eligible senior households.
For many businesses, in many states, PTET elections are yielding significant tax benefits. However, an area that hasn’t garnered significant attention is if the IRS would apply a “tax benefit” rule to owners of an electing PTE. If the IRS were to apply a tax benefit rule, SALT workarounds may be significantly curtailed for businesses with multi-state sourced income with PTE owners relying on a resident credit.
Businesses should weigh the potential benefits along with the risks in determining the right course of action. As different factors will play a role in businesses considering making elections into entity-level taxes, it is crucial that all the various considerations are modeled out. With proper planning and implementation, PTET elections can be a valuable state tax planning strategy.