Tag Archives: Pass-Through Entity Tax (PTET)

The Lost Years — Part 2: Business

Text PPP LOAN on tablet display in businessman hands on the white bakcground. Business concept

{14 minutes to read}  This is the second of two newsletters, with a look-back on the “Lost Years.” The first newsletter was individual-focused, and in that article, I discussed topics such as primary home sales, retirement withdrawals, pandemic residency audits, and the necessity of a written will, among others — in case you missed it, you can see the entire article here. 

Before I get into the article, if you are self-employed (that is you are a Schedule C filer) and you received Pandemic Unemployment Assistance (PUA) during the pandemic, the state’s departments of labor have begun sending notices requesting more information to substantiate your claim eligibility. Less commonly, these notices were also sent to a few W-2 employees. Schedule C filers have an extra hurdle to cross, signed affidavits from a person(s) verifying your self-employment. The letter may feel threatening, nonetheless, it is important to respond and provide what you have, to prevent the department of labor from requesting that you repay the funds received. Click Here for the landing page for the PUA Documentation request by NYS. Do not hesitate to reach out if you should need my service.

As I proceed in this article, I will be focused on entrepreneurs (including independent contractors) and small-business. Below are the topics of focus:

1. Pass-Through Entity Tax (PTET).

2. Qualified Business Income Deduction (QBID).

3. Paycheck Protection Program (PPP) Loan, even if forgiven, is not taxable for most states – but not for all.

1. Pass-Through Entity Tax (PTET)

A buzzword among NYS business entities in the last few months is PTET. If you are an S-Corp or a partnership, you may also have received a notice from NYS about this tax.

So, what is it? In its simplest form, it is having certain companies which are pass-through entities (PTE) pay the personal taxes for their partners, members, or shareholders. In appearance, it is shifting the state taxes from the individual to the business. Ultimately, these individuals may be able to take a credit on their returns for the taxes paid by the company. Eligible business entities are partnerships (this includes LLCs that are treated as partnerships for tax purposes) and S-corporations.

Why was it implemented? For the states — it is getting the tax revenue upfront by having the company pay the taxes earlier, and it creates a form of reserve revenue. For the individual (which is the focus here), it is to mitigate the loss of the state and local deduction, often referred to as a workaround. You may recall under the past administration with the enactment of the TCJA (in effect from January 1, 2018 — December 31, 2025) — individual taxpayers are not able to deduct more than $10,000 of state and local taxes (SALT) paid during the year. This resulted in a large portion of state and local taxes paid by individuals via payroll and real estate property taxes not being deductible. For states like NY, CA, CT, and NJ, just to name a few — a large deduction has been lost, thus increasing their tax bills.

Note: Though the PTET is the term used by some states (such as NYS) — other states have a similar benefit. See a list of the states here. 

Is this an automatic process? For a few states (CT for example) it is mandatory. For some others (like NYS), an election is required. First, you may want to assess if the PTE has a state tax return filing obligation based on income sources, or one or more resident partners, members, or shareholders.

For NYS, an annual election is to be made on March 15th to pay the estimated taxes on time each quarter. The first quarter estimate is generally due on March 15th of each year. The election made for a given taxable year is irrevocable.  For NYS, the base tax is 6.85% for taxable income up to $2M and the highest tax rate is 10.9% for taxable income over $25M.

Very important Recent Updates:

  • NYS — In a recent update for the tax year 2022 only — NYS extended the deadline for making the election, the new date is September 15, 2022.`
  • NYC is also coming with a PTET — effective January 1, 2023, for eligible entities.

If the company pays the taxes, isn’t the federal going to limit the SALT deduction to $10,000?

The general rule is that the amount of the state taxes paid by the PTET is not required to be reported as a federal itemized deduction under SALT. It is reported as a dollar-for-dollar credit toward your state tax bill.

There are other benefits as well — one of which is on the federal side — the pass-through income is lowered. Self-employed income is also often lowered — thus less self-employed taxes.

To learn more about the NYS — PTET — here is a link to the frequently asked questions.

So, what’s my take on this — should a company go for it?

Yes, it can be a great tax benefit for some companies that have the cash resource to pay the tax liability for their partners, members, or shareholders. Once you are in — you are locked in for that tax year. 

For federal tax purposes, one advantage of the PTET is the company can take the PTET as a regular deduction like other tax deductions. Doing so will result in a lower net pass-through income to partners, members, or shareholders; which ultimately lowers their federal tax liability. 

Notwithstanding this advantage, there are some concerns to note, below are a few.  

•Some businesses may have inconsistency of cash flow during the year — which sometimes creates a shortage of funds issues; so, a company may enter a tax obligation (with the state) that it cannot fulfill. Underpayment penalties can the states require the company to keep its part of the deal. 

•Properly prepared periodic financial statements are necessary to assess the quarterly net income, on which the taxes are generally estimated. It’s important to have a close estimate of what the periodic (i.e., quarterly) net income will be. 

•Non-residents’ concern — not exactly an equal opportunity for all partners, members, or shareholders. 

•The PTET paid is taken as a credit on the personal tax return — some states may not allow you to take the credit — this is more common with non-resident partners, members, or shareholders. Take-away: do thorough due diligence. 

•Not an individual — if you are a partner, a member, or a shareholder but are not an individual, you are not eligible to take the credit under the current rules.

As you might imagine, this is not a clean-cut tax credit and one size does not fit all. Each company may need to assess the value of this benefit in its entirety for its partners, members, or shareholders as a whole.

Unfortunately, this is not currently available in some states to a single member LLC who files a Schedule C — often referred to as a disregarded entity — no pun intended; disregarded entity is a legitimate IRS tax definition for such an entity. 

2. Qualified Business Income Deduction (QBID).

This deduction is available to qualified PTE, including sole practitioners, and independent contractors. It may be worth your while to review the areas on Qualified Business Income Deduction (QBID) provides an additional 20% deduction of the Qualifying Business Income (QBI). This article was written in 2018 see the — note: The thresholds have been adjusted in subsequent years for inflation.

As noted in the article the deduction has a lifespan of eight years (2018 – 2025), as of the 2021 tax year four (4) years have now passed. Under the current tax laws, we have four more years left before this deduction expires. Most qualified businesses have received the deduction — my intent here is to share ways we can strategically manage this short-lived benefit. Below is a short list of ways to consider. 

•Invest and/or save the annual tax benefit on deduction. Here is an example, if the QBID is $20G, and you are in a federal 25% tax bracket – your tax benefit is $5G. 

•Payoff high-interest loans on credit card debts with the tax benefit of the deduction. 

•Contribute to education costs for the child – the beneficiary does not need to be your child or dependent — maybe it is a child you admire and want to invest in. This child could be a child of a friend, a family, a step-child, a grandchild, or a neighbor. The child need not live in the same state. Additionally, some contributors may also get a state tax deduction for contributions up to a certain amount – if they have a filing requirement in that state (resident or non-residents) and the state offers the deduction. Lastly, there may be some limitations if the beneficiary has multiple contributors. NYS you can get more information at this link for all states —  Alicia Hahn, an editor, wrote an excellent article on Forbes.com https://www.forbes.com/advisor/student-loans/compare-529-plans-by-state

3. PPP Loan, even if forgiven, is not taxable for most states – but not for all.

First, for those among us who received the PPP loan(s), there is an assumption that the PPP loan(s) received have been forgiven – ensure you have written documentation evidence from the financial institution which generated the loan(s). If you have not yet applied for forgiveness, you can still do so, however, you may be on the hook to repay a part of the loan, I encourage you to submit the forgiveness application(s) at your earliest.   

Next, the general rule is that the PPP loan(s) is not taxable, however, some states may impose an income tax on a PPP loan. It does not matter if the loan is forgiven or not. So which states are imposing a tax – Katherine Lougheed wrote a detailed article for the Tax Foundation, among the states are FL, NV, VA, and UT, see the others in the article here — https://taxfoundation.org/state-tax-forgiven-ppp-loans

Before I close, there are still pandemic funds on the table for eligible employers – this is the Employee Retention Credit (ERC) – this is a payroll tax credit for an employer with at least one employee (that employee could be only you, the owner – this is generally an S-Corp shareholder) and have payroll reporting to qualify. To learn more about the eligibility, speak directly with your payroll provider.

In closing, my intent is not to undermine the devasting impact of the pandemic on businesses & self-employed as a whole. Some, even with the extra help from the government, were not able to be resuscitated, while others are still trying to survive. Nonetheless, through the lens of a tax professional for entrepreneurs & small businesses, and an entrepreneur myself, in recent years the changes enacted by the US government have been more tax-savings and loan distribution friendly. Since the TJCA was enacted – beginning 2018, a large number of entrepreneurs (including sole practitioners/independent contractors) and small businesses, have been paying much less in taxes. In response to the financial devastation of the pandemic on businesses – under the CARES Act, the U.S. Small Business Administration (SBA) extended several loans to entrepreneurs & small businesses, which would not have qualified under “normal circumstances.” One such loan is the PPP loan – which may be fully forgiven if certain required steps were taken. 

Let’s resolve to be more strategic by using this short-lived benefit in more worthwhile ways. We have 4 years left to capitalize on the (QBID).

Thank you for reading – I hope you find all or some part of this information useful to you. If you should require my service, please don’t hesitate to reach out. 

With gratitude,

Nadine

Nadine Riley, CPA
Founder, Masterpiece Accounting Group
Phone: (212) 966-9301
Email: info@mpagroupllc.com

The Masterpiece Accounting Group web, blogs, and articles are not rendering legal, accounting, or other professional advice. Tax strategies and techniques depend on your specific facts and circumstances. You should implement the information in this newsletter only with the advice of your tax and legal advisors.   

What Have You Gained in the “Lost Years?”

Text Think about tomorrow today on notebook

This is the first of two articles – this first one is more individual-focused; the next will be focused on entrepreneurs (including sole practitioners/independent contractors) and small-business. In that article, I will discuss Pass-Through Entity Tax (PTET) and ways to manage the generous but short-lived Qualified Business Income Deductions (QBID).

But first, let’s look back before we look forward. 

In most of my recent interactions with others, the term “lost years” is becoming a part of our conversation. I must say, the first time I heard it, I was a little taken aback. Why would we define them as lost years?

Despite the added responsibilities, I must say that in the past two years I’ve learned more about the beauty and fragility of our being, i.e., human beings, than all my years combined. I have learned that we need each other more than we can ever fathom. We also need a space for solitude, yet as Amanda Gorman expressed in her poem, The Hill We Climb: “… we’ve learned that quiet isn’t always peace.” Learning to wisely balance/manage time with others and time with self can be enriching to our overall well-being.

The years 2020 and 2021 are not lost years. Sadly, we have lost so many of our loved ones during these years and have seen the health of others deteriorate from the lingering side effects of COVID-19. Yet, even in the chaos, some among us have been transformed. Time did an article titled, “Even if You Feel Like This Was a Lost Year, That Might Not Be True.” In the article, the writer looked back at 2020 and wrote how some survivors of trauma, “found that after time, a significant portion of them report feeling renewed. They have a sense of fresh possibilities in life, an openness to following new pathways.” (You can read the entire article here.)

Moving Along to Taxes

You may have heard this echoed from other tax practitioners — this was one of the longest tax seasons! Most of us, including myself, felt like tax season started in January 2020 and didn’t end until the end of April 2022. Think about it — the IRS was given the task of administering most of the pandemic monetary distributions, and as we all know, whatever sits on the IRS’s shoulders falls into the laps of tax practitioners.

In this article, I will share some big moves made by individuals and their impact:

1. Primary Home Sales: One of my indirect mentors noted that of his 40+ years in business, he saw the most home sales in 2021. For primary home sales – under Code §121, the IRS allows an individual taxpayer to exclude up to $250,000 of profit/gain on a home sale (and up to $500,000 if jointly owned) when certain rules are met. While there are multiple complexities to these rules and some decisions may lead to losing all or part of the exemption, in its simple form these rules are:

a. They must have owned the home for at least two of the last five years;

b. They must have used the home as their principal residence for two of the last five years; and

c. They must have not excluded a gain on a home sale in the last two years.

2. Retirement Withdrawal and its Future Tax Effect: In 2020, a large number of individuals took money from their retirement savings and chose to have the taxes due on the withdrawal taxed over a 3-year period. While the tax impact was minimal for most in 2020 – the impact on the portion allocated for 2021 has propelled some individuals into a higher tax bracket. If you would like to cushion the tax impact for the 2022 allocation, consider replenishing your retirement savings by making tax-deferred contributions.

3. Residency Audits: People who moved during the pandemic appear to be returning “home.” If you are one of the many individuals who claimed to have moved from a state (which was your primary residence before the pandemic) with a personal income tax obligation to a state with no personal income tax obligation, and are considering moving back home, be mindful that this will likely trigger a residency audit. Residency audits are quite complex, and the burden of proof often lies with the taxpayer, which means you are guilty until proven innocent. Having adequate documentation can be crucial to defending your case. Each case is unique, and one size doesn’t fit all in a residency audit. Don’t go it alone.

4. Growth of Personal Savings During the Pandemic: Though most among us have lost a sizeable portion of our income in the last two years, many of us have saved more than in previous years. One notable factor was we spent much less on the “nice to haves,” since we were isolated and had no one to impress. Sincerely, I say this — most of our spending is often to impress others. Another factor that impacted our savings positively was that we eliminated many of those valueless subscriptions that are automatically billed and paid.

5. Amateur/Rookie Investors (Stepping Into the Role of Investment Manager):  Many among us used the time at home testing the various waters as investors and have profited from these trades/sales. However, a vast number of individuals did not set aside money to pay the tax liability on those gains. I have received 1099-B brokerage statements this year with over 200 pages. These statements entail short-term gains and “wash” sales. (A wash sale is triggered when an investor sells or trades a security at a loss, and within 30 days buys another similar security.) Short-term gains do not get favorable capital gain treatment, and wash sale losses are not allowable. 

6. The Will: Yes, you read correctly. At the time I drafted this article, I asked Google’s search engine — What is a Will? Over 14 million responses were generated, telling me that a Will matters. A Will is simply a legal document that states how you want your belongings to be handled and cared for after you pass away. A common misunderstanding about a Will is that if one does not have “heirs” then it is not necessary, but this is not true. If this is your thinking, consider this — many of us have resorted to animals for companionship and friendship and may have placed a higher value on our relationships with them than those with human beings. In our Will, we can choose who and how our companions are to be cared for after we have passed. 

Another reason I believe a Will is a necessary document is that it is a written document that expresses how you would like your remains to be handled. This is a selfless act of kindness. The grieving process is overwhelming to our loved ones, but when we make certain preparations in advance, we demonstrate how much we care for them. While a Will may not protect us from family grievances and bickering, in a Will we can state how we would like our ‘remains’ to be handled and who among our heirs should receive what.

If you would like to work with someone sensitive and caring in these matters, please reach out to me.

In closing, as I looked back at the past two years — for me, they were years of gains. Through 2020 and 2021, I have certainly attended the most wakes/funerals when compared to the last 10 years, yet I feel I have grown more within — more unmasked — less inhibited — more vulnerable and am much freer. I’m sincerely grateful for the meaningful and genuine conversations that were part of this experience. I’m equally grateful for the opportunity to serve others in this privileged capacity, and humbled when I reminisce on the ebbs and flows of this role.

Thank you for allowing me access to you – at times that access may only be a peephole. Other times it could be a window, while still others it is an open door.  Whatever level of access you provide, I am equally grateful for each. I am reminded of a scripture that depicts the loving nature of our Creator as he stands at our doors and knocks, saying:

“Here I am — I stand at the door and knock. If anyone hears my voice and opens the door, I will come in and eat with that person, and they with me.” 

May we resolve to let him in and allow him access to our lives. We can start with a small peephole. Only God knows how He will use this access to transform us for His goodness, but He will.

Nadine Riley, CPA
Founder, Masterpiece Accounting Group
Phone: (212) 966-9301
Email: info@mpagroupllc.com

The Masterpiece Accounting Group web, blogs, and articles are not rendering legal, accounting, or other professional advice. Tax strategies and techniques depend on your specific facts and circumstances. You should implement the information in this newsletter only with the advice of your tax and legal advisors.