Consequences of PTET Liability Shift Coming to Light

As new pass-through entity tax (PTET) regimes sweep across the U.S. with the intent of providing federal relief to individual taxpayers, there are nuances of implementation that merit special attention.

At first blush, PTET elections seem like a slam dunk, especially for individuals with significant state tax liability. What isn’t to like?

• The tax is computed and paid at the pass-through entity level.
• The entity and its owners are permitted a federal deduction for taxes paid in determining ordinary income.
• The individual owners receive a state tax credit for their share of taxes paid by the entity or, in some cases, an exclusion of the related income.

However, as details of this new tax are being fleshed out from state to state, departments of revenue, tax practitioners, and taxpayers are beginning to better understand the unintended consequences of implementation. Specifically, this opportunity shifts the state income tax liability from the individual to the entity and could result in a cash crisis at the entity level.

The idea of pass-through entities paying state income tax on behalf of their nonresident owners should not be newsworthy, as several states mandate withholding or composite tax. However, the remittance of income tax at the entity level on behalf of resident partners is novel. Pass-through entities need to be prepared to shoulder this burden. In addition to the obvious cash flow impact, the entities need to be cognizant of the timing and compliance of such payments. On the flip side, the PTET credit may impact the resident individual’s personal income tax payment requirements.

Questions that should be asked on a state-by-state basis include:

• When is the PTET payment due?
• Are quarterly estimates required?
• Is there a safe harbor provision?
• Does the PTET satisfy any nonresident withholding or composite tax requirement?
• Can individuals take into account the expected PTET credit for purposes of computing individual estimates and/or extensions?
• When will owners receive the federal deduction for the PTET expense?

Electing to pay PTET in a state still may have significant value to a taxpayer, and the aforementioned complexities should not negate the need to consider it. But care should be taken to ensure the underlying benefit does not get washed away in penalty and interest due to failure of proper and timely compliance.

To determine whether making a PTET election is truly beneficial, please reach out to your KSM advisor or complete this form.