{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.