New Pass Through Entity Tax (PET)
on CT S Corporation and Partnership Owners
Hello Everyone,
As a direct response to recent Federal tax reform, which limits State and Local Tax (SALT) tax deductions as an itemized deduction on your Federal tax return to just $10,000, CT Governor Dan Malloy signed a new “Pass-Through Entity Tax” into law on May 31, 2018. This is pretty much hot-off-the-press, and the rule can change, in fact the IRS is already working on ways to kill it, but my job here to keep you all informed, so I’m just going to go for it and tell you what I know so far.
In short, here is how the new CT PET Tax is supposed to help: Let’s say you have a K-1 profit from your S Corporation or partnership for $100,000 (to keep the math easy!). You’d generally owe CT income tax on that profit for 6.99%, or $6,990 for the tax year. Under the new CT PET Tax, you still pay the $6,990, but at the business level instead of at the personal level. What does this accomplish? Remember, your personal SALT deduction is limited to $10,000 on Schedule A of your Federal Form 1040, so moving the $6,990 to a deductible business tax now gives you the ability to take a Federal tax deduction for the $6,990. As such, your Federal K-1 taxable profit will be $93,010 instead of $100,000.
I’ll post links to the full Bill and the related implementation guidance at the bottom of this message, but to save you the boring read, here is a summary of how the new tax will work:
The New CT Pass Through Entity (PET) Tax
- Pertains to all tax years starting January 1, 2018 and subsequent years
- Pertains to K-1 Recipients in CT-based S Corporations and Partnerships (and CT-based LLC’s that are taxed Federally as S Corporations and Partnerships
- Does not pertain to sole proprietors or single-member LLC’s that file a Schedule C on their personal Federal Form 1040 tax return
- The tax itself is 6.99% CT PET Tax of the entity’s profits, which will need to be paid at the business entity level (under the business EIN).
- At the individual level, on your personal CT tax return, you would receive a credit for 93.01% of the CT PET Tax that your business entity paid, so in the example above, that would be 93.01% of $6,990, or $6,501. CT state keeps the $489 difference, which is what we think will make this qualify as a true, bona fide business tax, making it deductible for Federal tax purposes.
- The CT PET tax is mandatory, not elective, a move which impacts non-CT resident owners in CT pass-through businesses negatively.
- The move is “revenue-neutral” for CT state residents, so is essentially a Federal SALT deduction workaround. While it’s nice for owners of pass-through entities, it doesn’t help your typical W-2 wage earner. (CT passed a separate law allowing municipalities to setup 501c3 agencies to collect “donations” in lieu of property taxes, but I think the IRS will be able to kill that one fairly quickly).
How To Pay the New CT PET Tax
- Estimated quarterly tax payments of the CT PET tax would be due on April 15, June 15, Sept 15, and Jan 15
- CT recognizes that passing the new law this late in the year, retroactive to Jan 1, 2018, will cause all taxpayers to immediately be late on paying the CT PET tax. So they ask that you start with the June 15 payment
- CT will allow you to re-characterize all or a portion of your 2018 personal CT estimated tax payments, including those you have already made, to move those dollars over to your business EIN. You will have until December 31 to do that, and CT will issue guidance by September 30, 2018 on how to go about this re-characterization.
- In the meantime, if you want to go ahead and start making CT PET Tax estimated payments, CT recommends using the payment vouchers at the link below to make your CT PET tax payments:
http://www.ct.gov/drs/lib/drs/forms/1-2018/composite/ct-1065ct-1120sies-fillable0618.pdf
The True Impact to You, and To Our Office
- Overall, this new CT PET tax is supposed to save you Federal tax. While that is a good thing, there are some drawbacks.
- You now really need to differentiate between CT Personal Income Tax and your business CT PET Tax when you make your quarterly estimated tax payments, in order to get the amounts correct. So that means running 2 separate sets of calculations, based on a breakdown of your income sources.
- The CT PTE tax is the top CT rate of 6.99%. Many of you aren’t currently subject to that top tax rate and haven’t been making estimated tax payments at the maximum rate, so from a short term cash flow perspective, this will feel like a CT tax increase, until you are “made whole” on the 2018 tax returns next tax season by getting the personal credit for 93.01% of the CT PET tax paid.
- Many of you aren’t able to make your estimated quarterly tax payments on a timely basis, and the introduction of the new CT PET Tax could result in additional CT penalties and interest that you weren’t subject to before.
- For those of you who have been on-the-fence about switching to a partnership or S Corporation, this new tax treatment may help tip the scales in favor of making the switch. However, the IRS wants to kill this new tax before it starts, so we end up a bit in limbo on what to do in the meantime.
- Non-CT residents get hit with a tax increase here, as they’d be subject to the CT PET Tax, without the ability to claim the offset on a CT resident personal income tax return. And so they would end up being double-taxed by also owing tax on the same K-1 income to their resident/home state.
As stated earlier, this is all new info and is subject to change rapidly, but at this point in time the CT law has been passed. So the ball is now in the IRS’ court to see if they can challenge or defeat it. As always, we’ll be following this closely and you’ll be the first to know if any of this changes.
If you’d like to book a tax planning session to figure out how all of this impacts you or a fellow business owner, please reach out to our office quickly to book an appointment!
Best,
Robert Gambardella, CPA
203-767-7197
Additional resources for you:
Link to CT Guidance on Implementing the New CT PTE Tax:
http://www.ct.gov/drs/lib/drs/publications/pubssn/2018/sn2018-4.pdf
Link to the Full Senate Bill #11, Public Act 18-49:
https://www.cga.ct.gov/2018/ACT/pa/2018PA-00049-R00SB-00011-PA.htm
Article from CTBIA About How The CT PTE Tax Came to Be:
https://www.cbia.com/news/small-business/connecticut-salt-tax-fix/
