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Illinois Enacts Pass-Through Entity Tax to Help Partners and S Corporation Shareholders Avoid the $10,000 SALT Cap

Illinois enacted a pass-through entity tax (PTE Tax) that may be elected by partnerships and S corporations to permit a federal deduction of state income taxes that otherwise are limited to $10,000 per year from 2018 to 2025 by the Tax Cuts and Jobs Act of 2017 (TCJA). State income taxes paid by individuals, whether attributable to pass-through entity income or other income, are subject to the TCJA’s $10,000 “SALT Cap.”

In Internal Revenue Service (IRS) Notice 2020-75, the IRS announced its approval of the federal deduction of state PTE Taxes paid by the entity in circumstances where the partner or shareholder receives a state tax credit, and the PTE Tax essentially is paid in lieu of the state income tax otherwise imposed upon the partner or S corporation shareholder.

The new Illinois PTE Tax was signed into law by Governor JB Pritzker on August 27, 2021 (Public Act 102-658) and applies to taxable years ending on or after December 31, 2021, and prior to January 1, 2026. Eighteen other states have also enacted PTE Taxes and 14 of those (including Illinois) are effective for 2021.

TAX AT ENTITY LEVEL

The Illinois PTE Tax is imposed on electing partnerships and S corporations at a rate of 4.95%, the flat income tax rate applicable to individuals. The tax is imposed upon the Illinois net income of the partnership or S corporation, which is equal to Illinois base income after apportionment or allocation. As discussed below, partners and S corporation shareholders may claim a refundable Illinois credit equal to their distributive share of the Illinois PTE Tax paid by the partnership or S corporation. Illinois base income of a partnership or S corporation for purposes of the PTE Tax is computed without deduction of Illinois net loss carryovers or the standard exemption. It’s also computed after addback of the partnership subtraction modification for reasonable compensation of partners (including guaranteed payments to partners) and the subtraction modification for income allocable to partners or shareholders subject to the Illinois “replacement tax.” The PTE Tax does not affect the replacement tax computation.

The Illinois PTE Tax is paid by the partnership or S corporation on all of its Illinois net income after apportionment or allocation. As a result, any tax exempt owner of a partnership or S corporation may be required to file Illinois refund claims in order to recoup PTE Taxes paid at the entity level (including as estimated payments). In some cases, this may be avoided by forming an upper-tier partnership for partners that are not tax exempt. Other states have avoided this problem by permitting the PTE Tax to be elected on a partner-by-partner basis rather than for the entity as a whole (e.g., California) or by imposing the PTE Tax only upon income that is allocable to partners subject to the state’s personal income tax (e.g., New York State).

TIERED PARTNERSHIPS

In the case of tiered partnerships, if a lower-tier partnership makes the PTE Tax election, the upper-tier [...]

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Tax in the City: March Key Takeaways

McDermott hosted the first Tax in the City® meeting of 2018 in its Chicago office on March 15, 2018. Tax in the City® is a discussion and networking group for women in tax aimed at fostering collaboration and mentorship, and facilitating in-person connections and roundtable events around the country.

The Chicago program was one of the best attended Tax in the City® events to date, featuring a CLE/CPE presentation about the State Tax Impacts of Tax Reform by Cate Battin, Alysse McLoughlin and Diann Smith, followed by a discussion of Employee Benefits Impacts of Tax Reform by Diane Morgenthaler. The roundtable portion of the event covered federal tax reform issues, such as effects on partnerships, the GILTI tax, the BEAT tax, followed by an update on South Dakota v. Wayfair, a United States Supreme Court case reexamining the physical presence requirements for state sales tax collection nexus.

Key State & Local Tax Takeaways from Tax in the City® Chicago

  1. Without legislation at the state level, any tax payment impact from the federal repatriation transition provisions will all be concentrated in one year for state tax purposes, as opposed to the federal level where the impact will be spread over eight years.
  1. A company may have a GILTI issue at the state level, even if not at the federal level, because the states don’t take foreign tax credits into account.
  1.  Conforming to GILTI may create unconstitutional discrimination against foreign commerce.
  1.  States and taxpayers need to consider upon which federal return lines the new provisions will appear and how special statements, such as the repatriation statement, will map to state calculations the return and what schedules are used.

The next Tax in the City® meeting will take place in Seattle, WA on May 22. Please reach out to Mia Dubinets at mdubinets@mwe.com if you’d like to be added to the Seattle Tax in the City® mailing list, and receive invitations for the May event.

We invite all tax professionals who identify as female to join Tax in the City® official LinkedIn group to continue the conversation and share tax developments in between events and meetings! Click here to join.




Implications of Federal Partnership Audit Rules for State and Local Taxation

The new federal partnership income tax audit rules, scheduled to take effect on January 1, 2018, will have significant implications for the state and local taxation of partnerships and their partners. Most, but not all, states that impose a net income-based tax adopt by reference the federal definition of taxable income, but those that do typically adjust that income to reflect differences between state and federal tax policies. Moreover, state revenue departments generally do not regard themselves as being bound by Internal Revenue Service interpretations of the Internal Revenue Code even when substantive Code provisions are incorporated into state law by reference. The federal statutory rules relating to partnership audits are procedural rules and not ones of substantive tax law, so they will not be automatically adopted by states that generally conform to Internal Revenue Code provisions relating to taxable income. State legislatures may decide to adopt some or all of the federal statutory rules, or they may decide to adopt none of them. Arizona has already adopted its own version of the federal rules, and other state revenue departments are considering recommending to their legislatures that the legislatures take similar action, but most states have not reacted to the federal rules at this time. (more…)




Join McDermott Partners at the NYU SPS 2015 Summer Institute in Taxation

July 13-24, 2015
New York, NY

Join today’s leading national and international tax authorities, including McDermott partners Art Rosen, Peter FaberAlysse McLoughlin and Mary Kay Martire, for the NYU SPS 2015 Summer Institute in Taxation. The institute will feature a series of in-depth sessions on state and local taxation, partnerships, consolidated returns, trusts and estates, federal wealth tax and international taxation.

To register or for more information, please click here.




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