Optional Tax for New York Businesses

Kimberly Wright at BST & Co. has been walking clients through an optional New York state tax that’s relatively new for partnerships, multi-member LLCs or S corporations

The elective pass-through entity tax was included as part of the New York state budget two years ago and has been enacted by a few states in response to caps on the federal state and local tax (SALT) deduction.

Wright said BST has around 50 clients that elected into the tax for 2021, when businesses had until Oct. 15, 2021 to decide, and expects that number to increase this year.

“It started because of the Tax Cut and Jobs Act,” Wright said. “When they put the limitation on SALT (state and local) tax because of their itemized deduction, it kept it at $10,000. A lot of states were looking to find a workaround because a lot of people were missing out.”

The $10,000 cap hurt wealthy earners in high-tax states like New York, where the average deduction claimed had been more than $22,000. Connecticut was one of the first states to come out with this workaround, she said, and a lot of the states have since come up with their own plans.

New York’s pass-through entity tax imposes an income tax directly on the pass-through entity instead of on the partners or shareholders. It is an optional tax.

Because it’s an annual election, she said some clients may chose to elect one year and not elect the next. The election must be made each year by March 15. But a firm’s CPA can’t just do it for them.

“New York state made it difficult for tax professionals to do this for clients, so there is work on the taxpayer’s behalf,” Wright said. “They have to do the filings by March 15.”

If elected, someone who had a pass-through entity taxable income of $100,000 would see a tax rate of 6.85%. Wright said the deduction at the entity level would be $6,850. That deduction would reduce a shareholder or partner’s income on their personal tax return. The result would be about $2,535 in savings at the federal level.

But it doesn’t make sense for every S corp or partnership to opt into this tax. Wright said there are different calculations based on if you’re a resident of New York or a non-resident partner and if your company’s revenue comes mostly from New York, or mostly from out of state.

“Where it makes sense is if you have a partnership with all New York resident partners or even if you do have non-resident partners that all of the income is sourced to New York,” Wright said. “That’s where you’ll get the best bang for your buck.”

The necessity of the tax could be short-lived. The SALT cap is scheduled to sunset in 2026, and the Biden administration has considered raising the SALT cap back up to $80,000 in negotiations for the infrastructure and other bills.

Once you opt in, Wright said, the S corp. or partnership is stuck with that decision for the year.

“[A client] would have to make estimates if they make this election and once you make it for the year, it’s irrevocable, so you’d still have to file and pay the estimates. If you don’t there is a penalty,” Wright said. “For most clients, we’ve been doing meetings along with them or giving detailed step-by-step instructions.”