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Pass-Through Entity Tax Deduction

By Jason Watson, CPA

Posted Friday, August 12, 2022

As you consider your tax planning strategies this year, please be aware that you might live in a state that has a pass-through entity tax (PTET) on the books for 2022. Why do you care? Well, it could provide you increased federal tax savings. Keep reading if you dare-

Way back in 2017, the Tax Cuts and Jobs Act was passed with a lot of cool tax deductions like the Section 199A qualified business income deduction. But life is one big equalizer, and Congress wanted to limit state and local taxes (SALT) to $10,000. This means either state income taxes or real estate taxes, or both, were severely muted. People in South Dakota owning a $600,000 house were like “what’s the big deal?!” People living in Oregon (second highest state income tax rate next to California) owning the same house were like “WTF, over?!”

So! States got creative and created a state tax that was deducted on partnerships and S corporations (otherwise called pass-through entities) resulting in lower federal taxable income. This tax was in turn credited to the small business owner resulting in lower state income taxes being reported on Schedule A on the business owner’s individual tax return (Form 1040). This also called the great SALT work-around.

Cash is cash to a business owner whether it is spent by the business or the human.

There are all kinds of rules, and not every business owner will benefit from the PTET deduction. As such, the tax planning for determining the efficacy of using this tax deduction is challenging. As such, and we totally understand this is a crummy deal, WCG’s fee for this tax planning add-on service is generally $800 to $1,000, and at least $2,000 for complex situations (multiple owners spanning multiple states). If you are one of those complex situations, we will attempt to lock in a fee range; however, at times we must go old school and simply use retainers and hours spent (which both we and clients tend to loathe).

How PTET Works

For those of you who are saying “Woah” this is news to me. PTET is struggling to gain substantive structure from state legislatures and the overall tax environment continues to be shifty. Some might replace the f with another letter.

At this time, we calculate that business owners who profit at least $100,000 in 2022 (that’s net business income – after payroll and all your other bills have been paid) will see the most benefit from the PTET deduction. Business owners showing less profit on their business tax returns are likely to find that the juice isn’t worth the squeeze.

Additionally, the IRS has released Notice 2020-75 which summarizes the behind the scenes tax deduction if you can’t get enough.

Next Steps

Frankly, it’s a long story, involving a lot of math, but the gist is that by electing into a PTET system, your federal tax liability should be smaller than it would otherwise be in 2022.

If you believe you would benefit from electing in, please take a look at the link below. Find your state, then do the math: take the % tax times your expected net business income (after bills and payroll, remember) and pay that in to your state prior to December 31, 2022. Sounds easy, right? To use nerdy accountants, Yes. So, if you are like “Tilt!” let’s chat.

https://wcginc.com/wp-content/documents/tax/PTET-State-Table.pdf

PTET Team

We have assembled a dedicated team for the PTET deduction and associated tax planning. They include-

Michelle Day, Tax Partner, [email protected], 719-428-3248
Megan Oeltjenbruns, Tax Manager, [email protected], 719-644-7207
Matt Church, Tax Manager, [email protected], 719-302-8693
Ethan Summers, Tax Accountant, [email protected], 719-425-2094

Please connect with your Client Manager or one of the PTET experts above, and we can determine the next steps.

Jason Watson, CPA is a Senior Partner of WCG Inc., a business consultation and tax preparation CPA firm located in Colorado Springs, and is the author of Taxpayer’s Comprehensive Guide on LLC’s and S Corps which is available online and from mostly average retailers.