States’ PTE Tax Elections: Status and Issues to Consider
Updated 5/19/2023
Almost 40 states now allow pass-through entities (PTEs) to elect to be taxed at the entity level as a workaround to the $10,000 federal state and local tax (SALT) deduction limitation known as the “SALT cap.” Only about 10 states with a personal income tax have not enacted a PTE tax election, and practitioners probably can expect several of them to enact elective PTE tax regimes this year. Because this is an evolving topic, states are amending legislation and issuing administrative guidance to address various issues as they appear.
States have generally approached the creation of elective PTE tax regimes one of two ways. Group 1 states, such as Colorado, North Carolina, and Wisconsin, allow members of a PTE to reduce their adjusted gross income by their pro rata or distributive shares of income from the PTE if the entity elects to be taxed at the entity level. Group 2 states, such as California, Illinois, and New York, allow PTE members to take a credit to offset their taxable income but still require members to include their distributive shares of income in their tax returns. Connecticut is the only state that has created a mandatory PTE tax in response to the SALT cap. A handful of jurisdictions, such as Washington, D.C., New Hampshire, Tennessee, and Texas have historically imposed entity-level taxes on PTEs.
While the intent behind these PTE tax elections is to benefit members of eligible PTEs, they are not simple elections to make, nor should they be entered into lightly. There are many issues to consider, both from a compliance perspective and an overall tax perspective, and a holistic evaluation of whether to make a state’s election will compare the total federal and state (PTEs, resident members, and nonresident members) net tax cost with and without the election.
The sections below list some of the most important issues to consider from a holistic perspective with examples of the kinds of approaches individual states take to address them, and provide a map of the PTE tax regime status across the U.S.
Making a PTE Tax Election and Compliance Issues to Consider
When must the election be made?
- Arizona – The election must be made by the due date or the extended due date of the business’s return, but owners must be given 60 days’ notice.
- Michigan – The election must be made by the 15th day of the third month of that tax year (that is, March 15 for a calendar year taxpayer).
Is the election binding or annual?
- Alabama – The election is binding until revoked.
- Arkansas – The election is made annually.
Is the election irrevocable?
- Georgia – The election is irrevocable.
- New Jersey – The election can be revoked electronically by the original due date of the return.
How do you make the election?
- Michigan – The election must be made by submitting an electronic payment via Michigan Treasury Online. No other manner of making the election (e.g., submitting a written election statement or making a payment outside the online portal) is valid.
- Wisconsin – The election is made on the PTE’s annual return.
Who is authorized to make the election on behalf of the PTE?
- Alabama – The election must be made by the PTE’s governing board or by greater than 50% voting control of the PTE.
- Idaho – The election must be made by each member of the PTE, or by an officer, manager or member authorized by law of the PTE’s organizing documents authorized to make an election.
- Maryland – The enacting bill is silent on this issue, as are the comptroller’s guidance and instructions.
Can tiered partnerships or PTEs with non-individual members make the election?
- Georgia – It depends on the tax period. For the 2022 tax year, PTEs can make the election only if all the PTE’s members were eligible to be S corporation shareholders. However, beginning in 2023, Georgia expanded who can make the election to include partnerships with corporate partners and partnership partners.
- Michigan – Qualified PTEs are not precluded from making the election if they have a tiered-partnership structure or corporate partners.
Are electing PTEs still required to comply with withholding or composite requirements?
- Illinois – Electing PTEs are not required to withhold on behalf of nonresident owners.
- Maryland – Electing PTEs cannot file a composite return on behalf of any member.
- New Jersey – Beginning in tax year 2022, the partnership will not be required to remit tax on behalf of any nonresident partner that reasonably expects to be refunded the payment because of its business alternative income tax credit.
Are nonresident members of electing PTEs still required to file returns?
- Arkansas – No, nonresidents are not required to file individual returns if they have no other Arkansas-source income.
- New Jersey – Yes, nonresidents must file returns if they meet the state’s gross income tax filing thresholds.
General Tax Issues to Consider
What is the tax rate?
- Minnesota – The state applies its highest individual income tax rate of 9.85%.
- New York – New York uses a graduated rate that reaches up to 10.9% if the PTE’s tax base is over $25 million.
How is the electing PTE’s tax base calculated?
- Colorado – The tax base is the sum of each electing PTE owner's pro rata or distributive share of the electing PTE's income attributable to Colorado and each resident electing PTE owner's pro rata or distributive share of the electing PTE's income not attributable to the state.
- Louisiana – The tax base is calculated as if the electing PTE were a C corporation for federal tax purposes.
- Michigan - Electing PTEs calculate and pay tax due only on the business income tax base allocable to members that are individuals, flow-through entities, estates or trusts and exclude the business income tax base allocable to members that are corporations, insurance companies or financial institutions.
How do members of the electing PTE report their shares of income?
- Arkansas (a Group 1 state) – Members exclude their shares of PTE items that are subject to tax under the PTE tax election.
- California (a Group 2 state) –Qualified taxpayers include their pro rata or distributive share of income in their California return, which may be offset with a credit.
Are net operating losses allowed, for the electing PTE or its members?
- Arkansas – Net operating losses generated by the PTE do not flow through to owners and may be carried forward by the PTE.
- Wisconsin – Electing PTEs cannot claim net operating loss deductions.
How do members of the electing PTE calculate their credit?
- Arizona – The credit is calculated as a portion of the tax paid by the electing PTE that is attributable to the partner’s or shareholder’s share of income taxable in Arizona. The credit is not refundable but can be carried forward five years.
- Massachusetts - A qualified member receives a refundable credit against its Massachusetts income tax. This credit is equal to the qualified member’s proportionate share of tax due and paid by the eligible PTE, multiplied by 0.9.
- Oregon – Members can claim a refundable personal income tax credit for their pro rata share of Oregon PTE tax paid.
Can nonindividual members take a credit? If so, is it refundable?
- Alabama – Corporate partners are entitled to a refundable credit.
- New Jersey – For tax years before 2022, corporate partners are entitled to a nonrefundable credit that can be carried forward 20 years. Beginning with tax year 2022, a member that is a C corporation is allowed a refundable credit against its surtax and regular tax but it cannot reduce its tax liability below the statutory minimum.
Are nonresidents allowed to take other state tax credits on their resident state income tax returns for elective PTE taxes paid in other states?
Most Group 2 states allow residents to take an other state tax credit for elective PTE taxes paid in another state. Because Group 1 states allow residents to reduce their adjusted gross income by their distributive shares of income from the electing PTE, a credit is unnecessary.
Whether nonresidents may take other state tax credits on their resident state income tax returns is one of the most important issues to evaluate for SALT purposes. If a state does not allow an other state tax credit for elective PTE taxes paid, then an individual may be trading a dollar-for-dollar state tax credit for a $0.37 federal income tax deduction by making a PTE tax election.
Federal Income Tax Issues to Consider
In addition to the high-level state issues discussed above, there are federal income tax issues to consider, such as:
- In which tax year can an electing PTE that is an accrual method taxpayer take a deduction for elective PTE taxes paid?
- Is an owner’s state tax refund attributable to the PTE tax credit considered taxable income?
- How is the state tax expense of an investment partnership treated?
- May the PTE’s state tax expense be specially allocated only to those partners whose income was included in the PTE’s state tax base?
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