We have received a number of questions related to the Pass-Through Entity tax and how it may affect you and/or your business. Here is the breakdown of how it will work going forward.
The Tax Cuts and Jobs Act (“TCJA) of 2018 put a $10,000 cap on the itemized deduction category for state and local taxes (“SALT”), which includes real estate taxes, state income taxes and other local taxes. Taxpayers who itemize deductions and have state and local taxes that exceed $10,000 lose the deduction for federal tax purposes of the excess of those taxes over $10,000.
Several states (including Connecticut, Louisiana, Oklahoma and Wisconsin) have adopted legislation intended to circumvent the Federal SALT cap of $10,000 by imposing an entity tax for pass through entities.
Rhode Island passed legislation, signed by the Governor on July 5, 2019, that provides for pass-through entities to make an election for tax years beginning on or after January 1, 2019 for the entity to pay Rhode Island tax on Rhode Island net business income.
- S Corporations
- Partnerships, including limited liability partnerships (LLP)
- Limited liability companies (LLC) not tax as C corporations (including a single member LLC)
- Unincorporated sole proprietorships (with Schedule E rental activities qualifying within this category)
How will this work?
- The pass-through entity must make an annual election to pay the entity level tax at the rate of 5.99%.
- Rhode Island is presuming that this tax will be allowed as a deduction on the Federal return of the pass-through entity thereby reducing the amount of taxable income from the pass-through entity to the owners.
- The pass-through entity will report to the owners the pro rata share of the RI entity tax paid by the entity. The pro rata share will be treated as a modification (addition to the income being reported) on the individual’s RI return and the individual will take a credit for the same amount on their RI personal income tax return.
- Pass-through entities who make the election must pay quarterly estimated tax payments to RI for the entity tax using Form BUS-EST. The entity will check “Pass Through Entity Election” box on the form in order to make the election. There are transitional rules that apply to this for 2019, it being the initial year of the entity tax.
- There are complexities when making the decision to make the annual election. They can result from situations such as multiple owners, some of whom may have a RI tax rate less than 5.99%, as well as owners who are non-residents of RI.
- There are transitional rules for 2019, since this is the first year of implementation, including:
- The entity tax for the business has to be paid on or before December 31, 2019 in order to be eligible for the deduction on their 2019 tax return.
- RI will not impose interest for late payments for 2019 if quarterly payments were not made on a timely basis.
- RI is in the process of revising several forms and related instructions so that they are fully updated to reflect the new law for the entity tax.
- A decision will have to be made for future years, regardless of whether or not an entity makes the election for the 2019 tax year, and the entity tax will have to be made timely on a quarterly basis.
Note of Caution
As mentioned earlier, several states have enacted similar legislation to circumvent the SALT cap, and the IRS has said that they will be issuing guidance on the matter. The IRS has not issued any guidance to date and there may not be such guidance by December 31, 2019. Should the IRS issue unfavorable guidance disallowing the tax deduction at the entity level, taxpayers may incur the cost of significant burdens for amending entity tax returns and individual income tax returns along with payment of the tax that would otherwise have been owed, as well as penalties and interest.
It remains a question whether the entity level tax will be allowed as a Federal deduction. Should there be nothing definitive by December 31, 2019, business owners (based upon the uncertainty) will have to make a decision whether or not to make the election for the 2019 tax year and pay the entity tax.
Please contact us at 401-831-0200 with any questions, or for guidance related to this or other accounting and tax matters.