By Peter N. Calcara, PICPA vice president – government relations
For the first time in several years, a real discussion about state tax reform is happening in Harrisburg, largely due to Gov. Tom Wolf’s proposed 2022-2023 state budget. With both the political and economic environments seemingly ripe for such a discussion, the General Assembly appears poised to address a variety of tax law changes. One important change that could appear on the legislative agenda is PICPA’s effort to address an area of growing inequity in state and local taxation: specifically, an elective pass-through entity tax (PTE tax). An elective PTE tax would provide certain federal tax benefits and is expected to correct the Department of Revenue (DOR) position that currently penalizes Pennsylvania resident partners for electing PTE taxes in other states.
The federal Tax Cuts and Jobs Act of 2017 (TCJA) changed much in the Internal Revenue Code, but the $10,000 state and local tax deduction limitation (SALT cap) for the 2018 through 2025 tax years is particularly notable. The SALT cap prevents many individuals from being able to fully deduct state and local income tax and property tax on their federal individual income tax returns. This limitation is exacerbated for those with multistate ownership interests in partnerships, S corporations, and certain limited liability companies (collectively referred to as pass-through entities).
To mitigate the impact of the federal SALT cap, a number of states have adopted statutes that facilitate the deduction of additional state income taxes on federal returns. These efforts are commonly achieved through the imposition of PTE taxes. The PTE tax is an entity-level income tax with a related credit for owners to claim on their respective state individual income tax returns. In the mid-Atlantic region, Connecticut, Maryland, New Jersey, and New York each enacted PTE taxes and legislation in Virginia is awaiting the governor’s signature. Across the country, 23 states have enacted PTE taxes to date, with several others considering enactment.
On Nov. 9, 2020, the IRS released IRS Notice 2020-75 acknowledging the federal deductibility of PTE taxes. This is a potentially significant federal tax benefit for pass-through entities in states with PTE taxes because these taxes are expected to be deductible for federal income tax purposes at rates up to 37%. There are, however, many factors at the state level that complicate the analysis of this benefit. In some cases, electing into a state PTE tax may actually increase one’s state taxes. Notably, Pennsylvania is one jurisdiction where electing into other states’ PTE taxes may increase Pennsylvania income taxes. This potential increase results from the potential loss of credits to Pennsylvania resident partners.
Generally, a resident owner of a pass-through entity is allowed a credit against Pennsylvania personal income tax (PIT) for taxes paid to other jurisdictions on the same income. Since Pennsylvania taxes its residents on all income, regardless of where it is earned, the credit is necessary to avoid taxation of the same income by Pennsylvania and other states. The absence of such a credit is likely to lead to double taxation – first under the other states’ PTE taxes, and then again on the Pennsylvania PIT return.
Concerning PTE taxes, the DOR has articulated its position that a Pennsylvania resident partner is not entitled to a credit against PIT, but a Pennsylvania resident S corporation shareholder is eligible for a PIT credit. DOR points to legislation specific to S corporations to support this disparate treatment and the potential double-taxation of partnership income. This means resident partners may face a Pennsylvania tax increase simply due to their inclusion in another state’s PTE tax return. Other states that had similar resident credit disallowance for partnerships affirmatively fixed the issue in their PTE legislation (New York and Virginia, for example).
House Bill 1709, sponsored by Rep. Martina White (R-Philadelphia) and pending in the House Finance Committee, would enact a PTE tax structure, and explicitly allow a credit for resident partners and S corporation shareholders. Members of PICPA’s Pass-Through Entities Tax Thought Leadership Committee are leading the charge to review and modify the language in House Bill 1709. Pennsylvania has an opportunity to enact a PTE tax as part of this year’s budget process to facilitate federal tax deductions for its residents and pass-through entity owners, keep pace with numerous other states, and revise its current position of penalizing its resident partners.
If you want to learn more about how you can help the PICPA government relations team advance this legislation, contact us at firstname.lastname@example.org.
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