How to Navigate Changes and New Guidance of the Pass-Through Entity Tax

So with PTT, what happened is Connecticut was the first state that came out with a mandatory PTT, which is an entity level tax. So basically you're shifting that individual limitation, the deduction from the individual to an entity, either a pastoral entity or an S corporation. And they're not limited to $10,000. So that's something that you get to fully utilize, take the full deduction, and that gets passed through the members. So your individual members, whether they're New York residents, New Jersey, or whatever state there is. So that is highly valuable, right, because you are cutting, you getting rid of the $10,000 limitation, which it's a burden for taxpayers that live in high tax jurisdiction like you in New York. I live in New Jersey, we pay well over $10,000 in real estate taxes, and that's not even including our state income tax and local taxes. So you can only imagine this $10,000 what of impact it created to taxpayers in those states. So that's really the PTT. And Andrew, would you like to talk about some of the benefits that you have seen? Yeah.

Andrew Cohen:

First of all, there was concern when it first came out whether the IRS will allow the deduction, and that was a big topic and eventually the IRS issued this noticed 2020 dash 75, which said they're going to pass these regulations, which it hasn't come out yet, but hopefully one day it comes out that will allow the deduction and that opened the doors for all the states to have a pass for ANTIT tax. Since that time, there's now 36 states that have a pass for antit tax. And there's only in the city, in the city too, in New York City. Yes. Yes. Don't forget, in New York City, and there's only six states right now, doesn't have pass rent that has income tax doesn't have it. Thedo states, Pennsylvania, Vermont, and Maine have legislation to pass a statute. So soon all the states will have this pasture on deduction.

DM:

So people can only imagine how busy our team is going to be. We don't have 50 people, but there are 50 states. So that's something to keep in mind. And these

AC:

States come out guidance every single week there's something new that comes out. You have to take ONT to keep track of.

DM:

And there are so many nuances with PTT. As Andrew mentioned, there are 36 states. Something to keep in mind is that there's no uniformity among the states. So every state have their own rules, different due dates, different forms, different requirements, eligibility and whatnot. So we do have a chart, a tool that we have our team put together and we highly update that frequently for all the state changes. So something to keep in mind that we can use to help you at least identify what states have a PE, what are the due dates, what are the forms, the estimates are required and whatnot. But I think with pt, some of the key areas benefits that you mentioned, the federal deduction, you want to talk about that a little bit more. How does this create a benefit,

AC:

Right? Yeah, exactly. So originally when you have partnerships like an S corporation, an LLC or income deductions flow to the partners and shareholders members and they pay the tax here, they kind of switch things up when now they said the entity pays the tax on the income and the amount of tax that they pay is a deduction on the federal return. And the main benefit is going to be we total clients the highest tax rate, which is now 37% multiplied by the deduction you take on the return. So for example, say a client takes a hundred thousand dollars deduction on the federal return, that's a $37,000 benefit that they wouldn't have if they didn't make the election. The other benefits is that on the individual partner shareholder level, they get either a credit on their state return for the taxes paid on their behalf or they get a reduction of income. Eight states have reduction of income, meaning that the K one income flows to that particular person. It's reduced by the amount of taxes paid on their behalf.

DM:

And also to factor that in, to include into that, it's that if we have taxpayers that sell a business asset or they have a disposition of a partnership interest, that generally creates a significant capital gain. And those are transactions that could create a large benefit from a standpoint. So something to consider, right? If you don't know what your income is going to be like and you expect and you end up having a large transaction, there could be a huge benefit created from that, right? Right. I mean, think about a taxpayer, they're going to be subject at 37% federal tax rate by having this piece that in place, they're obviously limited, they could end up being in a lower bracket. So something to definitely consider as, especially during this time of the year where we're all working on year end planning opportunities. Right, exactly.

AC:

So you also have to be cautious of the election dates. Right now, 35 states have an elective elective. You have to elect into it every single year in a few states where it's not yearly, but for the most part it's yearly elections. And if you miss the election date, you can't make the election. There's no late elections allowed.

DM:

And we have seen that with New York State a lot where taxpayers have uncertainty of what their income activity will look like at the end of the year. So they don't make an election and then turns out they have a large gain and they cannot go back and make an election. New York does not allow for a late election. So to the extent that you have this scenario or this situation, make the election, always recommend your clients make the election. Worst case scenario, if you end up at a loss or you don't end up having significant income, at least then the election is in, it's better to have it in as opposed to not being able to go back and reactively applied in election especially because this impacts the taxpayers, right? All the individual taxpayers that are going to be picking up the tax or the

AC:

Right and say you do pay estimated taxes through the year and you don't have an income at the end of the year, you get a refund. That's all. You get the money back. Exactly.

DM:

There's no loss. Exactly. And another benefit of this is that by making this pizza, the entity taking on the payment at their level, so you don't have the individuals making a separate quarterly estimate, right? There may be different rules for certain states, but overall you do move the responsibility from an individual taxpayer. If taxpayers are like me, I tend to forget things. It's kind of hard to keep track of all the estimates you have to make for every state. Having the entity make that for you, then it definitely creates a benefit. It's a relief. Other things we should talk about, it's California, right? Yes. We have seen this with California. It's one of those special states where if you don't, you have time to make an election by the due day of the return, which is March 15 of or by an extended due date, which is October 15. However, if you don't meet the requirement of a prepayment by the second quarter, which is June 15, California will not validate a P election. And we have seen that, right? I mean we're dealing with clients right now, we're like, well, I made it by three 15, but they didn't make the payment. So that could be detrimental to investors.

AC:

And you have to pay the right amount. The right amount in California is the greater of 50% of last year's tax, Butte tax or a thousand dollars

DM:

And the 50% would only apply if you made an election in the prior year. So as you can see, California has their own rules. New York has their own rules. You have to do it by three 15. There are just so many complexities that comes into PE and other things we're talking about. Obviously all the PE general guidelines, but there are other things that impact PT as well. Sourcing the type of entities we're dealing with that we're talking about pass through entity. It's in an S corporation. I mean we've seen this, right? Yeah, of course. For example, it make sense to do a PA for an S-corp where in certain cases versus a pass through entity. So those are things that we have to look at it from a planning standpoint is do we want to have an scorpion form or is it a pass through entity? Who are the investors? What type of investors? How do we want to create a structure, the entity where we can get the most benefit out of the BA, right?

AC:

Right. And Austin New Jersey has got special rules you got to follow too as well. The election of New Jersey is due the extended due date of the return. However, you have to make the election first to make a PPA payment. So even though they tell you you can wait till the end, you kind of have to make the election right away if even though you want to

DM:

Make the payments. That's right. And the same thing we have with Massachusetts, you make it with the return, but they are quarterly estimates. And before you do quarterly estimates, you have to create an account on the mass tax Connect. So you do have to do some other steps even though it tells you by a certain day you have to do it prior to that. So it's something to keep in mind. Other states, for example, require registrations like New Jersey, Jersey, mass, I believe, Ohio. It's another one that you have to have a registration. So by having a registration, people tend to forget, okay, I made an election in year one, I don't want to make it in year two. But since you are registered with the state, there is technically a file requirement. So things from the next standpoint, it may also be created because of ped. So again, they're all commingled with each other, right? You have sourcing analysis that go into place, apportionment entity structures, it's a very complex area. So basically the point we want to drive here is that it requires a special consideration and it should not be assumed that one state's rule applies to the other. So it's highly important to know that we have the resources in our team. Most of us have dealt with pt, and it's a great opportunity to get the team involved and work with your clients, have these conversations earlier on for planning

AC:

Purposes and we can advise our clients what to do. We've been

DM:

Exactly, yes. So that's on PTT. Another thing we want to also bring up, which it's a very valuable area which we have dealing with and we deal with is audit defense with residency issues, domicile statutes or residency, especially with covid. We had New York State, New York City had so many taxpayers like flee the state. They go to Florida, where do they go? States where they don't have personal income tax. Texas, Florida, New York State will say, oh, well look at you. You're going to stay where you're not going to pay any tax. So guess what, we're going to audit you. So this is where domicile residency issues come up and we deal with, so Andrew Care, talk about some of this domicile residency.

AC:

So domicile is the place where you spend your permanent home in where say you leave and you come back to you. That's your domicile. You only have one domicile. Now domicile is yours until you actually change it. And to change it, you have to land in another state or land somewhere else. You have to physically leave New York and land in, say Florida. That is going to be your change of domicile. And so some of the things you want to do to make sure you change your domicile is to really show the state New York that you did change your domicile. For example, stuff that's near and dear to you. Take with you to Florida, like your furniture or your dog or change your driver's license to the new state vote. Register to vote in a new state or get the exemptions for Florida has a homestead exemption. Make sure you get the homestead exemption done. Change your lifestyle so that all your holidays were spent in a new state. Your work activities in that new state,

DM:

I mean things like your primary physician, make sure you change that, your living will, things like that on a day-to-day basis or normal basis voting registrations you want to establish, the more steps you take on, the better chances you have to defend your position, whether you are a New York state resident or not resident. Right,

AC:

Because it's the tax phase burden to actually establish a change of

DM:

Domicile. Exactly. Exactly.

AC:

And also there's something called a statutory, you mentioned statutory residency. So even though you take all the effort to change your domicile, the state can still say we're taxing all your income because you're statutory statutory residence. And that happens when you still have a place in New York State or New York City, like in an apartment, and you go to that apartment more than 183 days during the year, they can say, well, you have a place for a boat. You can go there, you have access to it. You've been there more than 183 days. You're really a New York State residence though.

DM:

And also you mentioned, right, you can only have one domicile, but you can have more than one residence, right? Tax residents. So you could still be considered a New York resident, even though you may think you are a Florida resident, you can still be considered new resident if you don't take the appropriate actions, the appropriate steps to establish out of state residency.

AC:

So the defendant audit and you want to make sure you have a calendar close in time to when the next things happens because contemporaneous calendars does not help in an audit. So you want to have an Outlook calendar, you want to have somebody take track of your days so you know exactly where you were on a particular day.

DM:

Yeah, I mean nowadays there are so many apps that people can use, people can use and track their days. I mean, you'd be surprised. There are so many apps and features that you can do to, and there are companies there that will even track your days to make sure that you're not overpassing the days, the amount of days that it could trigger a residency. So the point here is that it is a complex area and it is highly valuable. Our clients may not be aware or they may not have the time to be involved in all these planning opportunities, which they come to us and rely on us for this support. So we do have the expertise and we have the resources to help with this type of opportunities. And it would highly suggest that people take advantage of that.

AC:

Just give us a call, we'll help you out,

DM:

Always available. If anybody has any questions, we're happy to participate in year end planning opportunities or discussions with clients or prospects or whatever need be. We have the right resources and the team available.

AC:

We have a good team.

DM:

Correct. So with all that said, we want to thank everyone for your time and hope you found this video helpful and we're always here to help.

AC:

Talk to you for you soon.

DM:

Thank you. Bye-Bye.

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