A major component of the Tax Cuts and Jobs Act of 2017 is the $10,000 annual limit on state and local taxes included in an individual’s itemized deductions. This limitation applies to tax years 2018 through 2025. As a workaround for owners of pass-through entities (PTEs), states have enacted elective pass-through entity-level taxes (PTETs) to allow individual PTE owners to obtain a benefit for the state taxes paid on their pass-through income. Pass-through healthcare organizations are typically partnerships or S corporations. PTET elections allow the states to impose income tax directly on the PTEs rather than the individual owners. The guidance provided in IRS Notice 2020-75 allows the PTE to include these elective tax payments as a deduction in determining non-separately stated income or loss. Many healthcare organizations are structured as PTEs and oftentimes those owners, such as physicians, pay state and local taxes in excess of the $10,000 annual limit referenced above. Assessing a potential benefit for owners is a timely consideration.
The exact implementation of the PTET elections varies significantly by state. The general process is as follows:
- The PTE makes the election.
- On that entity’s state tax return, it pays tax on any state income. This tax payment is included as a deduction on the PTE’s federal tax return and reduces non-separately stated income or loss.
- On the owners’ individual federal returns, this payment has already been included in their income from the PTE and is not separately reported.
- On the owners’ state returns, the state may allow a credit for an owner’s share of taxes paid by the PTE. Alternatively, the state may require a reduction in state-taxable income for income already taxed on the PTE’s return.
It is important to note that the PTET elections are designed to provide a federal benefit to individual owners. The total amount of state tax paid by the owners may increase or decrease as a result of making PTET elections, depending on the specific facts. The scenario which will most likely provide a net benefit to the owners is when the PTE has a large portion of its taxable income in a state with a PTET election and the owners’ resident state allows a credit for taxes paid to other states on payments made by the entity. As of July 2023, 36 states and one city have enacted PTET elections.
Healthcare organizations organized as PTEs should explore the applicability of PTET elections to their business and the potential benefit for their owners. As many physician offices/clinics operate in a single state, the complexity of the election might be minimal. Organizations operating in multiple states will need to go through a more thorough analysis of the impact of the election. Regardless of the level of complexity, the PTE election may provide a significant benefit to the owners. Working with professionals experienced in PTE elections can help confirm that the federal benefit outweighs any potential increases in state tax.
Below is a list of states with PTET election opportunities, as well as the year the election became effective:
| State/Jurisdiction | Effective Year |
|---|---|
| Alabama | 2021 |
| Arizona | 2022 |
| Arkansas | 2022 |
| California | 2021 |
| Colorado | 2018 |
| Connecticut | 2018 |
| Georgia | 2022 |
| Hawaii | 2023 |
| Idaho | 2021 |
| Illinois | 2021 |
| Indiana | 2022 |
| Iowa | 2022 |
| Kansas | 2022 |
| Kentucky | 2022 |
| Louisiana | 2019 |
| Maryland | 2020 |
| Massachusetts | 2021 |
| Michigan | 2021 |
| Minnesota | 2021 |
| Mississippi | 2022 |
| Missouri | 2022 |
| Montana | 2023 |
| Nebraska | 2018 |
| New Jersey | 2020 |
| New Mexico | 2022 |
| New York | 2021 |
| New York City | 2022 |
| North Carolina | 2022 |
| Ohio | 2022 |
| Oklahoma | 2019 |
| Oregon | 2022 |
| Rhode Island | 2019 |
| South Carolina | 2021 |
| Utah | 2022 |
| Virginia | 2021 |
| West Virginia | 2022 |
| Wisconsin | 2018 |
Forvis Mazars can assist you with analyzing the impact of PTET elections on both federal and state taxes, as well as plan for cash flow impact. For more information on how PTET elections may impact your company and its owners, please reach out to a professional at Forvis Mazars