Massachusetts New PTE (Pass-Through Entity) Tax Legislation
Since the passing of the Tax Cuts and Jobs Act, many taxpayers have been severely limited by the SALT (state and local tax deduction) limitation of $10,000. Business owners and high-income earners often pay large amounts of state taxes that would previously have been deductible on Schedule A when itemizing deductions. The law was passed September 30th, 2021 and on the surface appears to be an additional tax burden, when in fact this is good news for Massachusetts taxpayers. Other states have enacted this workaround to allow additional deductions that are no longer allowable on Federal tax returns, and Massachusetts is following suit. You can read more details about the bill here.
Who does this affect?
This new law will affect any taxpayer with pass-through income. Pass-through income is reported on federal form K-1 and is generally from ownership in passive or active businesses or investments. Form K-1 is issued to owners in Partnerships, S-corporations, and LLCs and reports applicable income and deductions that effectively flow through to the owner’s tax return. This law will affect any taxpayer in Massachusetts that receives this form and therefore reports pass-through income on their federal income tax return (Form 1040).
How does this benefit taxpayers?
Essentially, most business owners pay their state taxes right out of their pocket. The taxes are paid at the state level, and the Federal government allows the said taxpayer to reduce their taxable income on their taxes by the same amount, effectively reducing their amount of taxable income. This deduction is captured on Schedule A when itemizing deductions (and not taking the standard deduction). This new pass-through entity law allows for business owners with pass-through income to make an election, and therefore pay all of their state income taxes through the entity. Making this move allows the business to write off the entire amount of taxes paid as an expense, where otherwise they would have been limited by the SALT deduction limit mentioned above. This will reduce the amount of taxable income flowing from the entity to the taxpayer via Form K-1, and will reduce their tax liability.
Are there potential issues with making this election?
This election is ideal for business owners in Massachusetts that pay more than $10,000 in state and local taxes. However, many businesses may have owners from various states or owners at different levels of income. This is an issue to greatly consider as making this election will not benefit every owner in the business when there is a lot of out-of-state activity. There are many ways to structure state payment by owners in the business, but generally, when making this election the business will pay the state tax and allocate per partner on the K-1. In short, business owners should do extensive research on this election and consult their CPA to make sure that they are making the best decision for themselves and the other owners in their business. Follow this link for comprehensive Massachusetts guidance on pass-through entities.
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