PTE Tax Can Help States and Taxpayers When Drafted Carefully

With the $10,000 for state and local tax cap set to expire in December 2025, holdout states have less than two years to take advantage of pass-through entity tax benefits and include some form of retroactivity to make up for lost time.

Thirty-six states and New York City have adopted a PTE tax. Although the PTE tax workaround makes compliance for state tax administrators more complicated, it does the same for tax professionals and taxpayers. But if drafted tactfully, the tax presents an opportunity for both states and taxpayers.

TCJA Workarounds

After the SALT cap went into effect with the Tax Cuts and Jobs Act, states sought avenues to provide relief to their taxpayers. Most early attempts to circumvent the SALT cap—which involved being given income tax credits for donations to a state-operated charitable fund—were ultimately shot down by the IRS and Treasury.

The workaround deemed most acceptable was a pass-through entity tax introduced in Connecticut under SB 11, signed into law in May 2018. The tax is paid at the entity level where no SALT cap exists, resulting in an indirect tax deduction for state income taxes paid that may not be able to be deducted at the individual level.

After Notice 2020-75 was issued in 2020—the latest guidance to date—legislators in many states moved quickly to enact their own version of a PTE tax to provide the benefit to their taxpayers. While well-intentioned, some may have been enacted without appropriate consideration as revisions to the tax to address gaps in original legislature haven’t been uncommon.

Pennsylvania

The Pennsylvania Department of Revenue in March told lawmakers that it opposes SB 659, which would authorize a PTE tax election in the state. The agency indicated that the legislation could have a large fiscal impact on the budget due to timing shifts. It also noted it would be burdensome to administer refunds for tax returns already filed for the 2023 tax year.

While these concerns are valid, it’s reasonable to believe that the state can adequately address these challenges, considering the success of the 36 other state departments that adopted the tax and who also have balanced budget requirements. It would appear the state has the flexibility to deal with timing issues if necessary, as it’s been reported that Pennsylvania is projected to have a $14 billion budget surplus at the end of the 2024 fiscal year.

Looking Ahead

In the worst-case scenario, states decoupling from Section 164(a)(3) of the Internal Revenue Code—therefore requiring an addback adjustment for state and local income taxes deducted at the federal level—could theoretically break even from a revenue standpoint.

The upside is the ability to generate additional revenue through various approaches, such as providing a credit for less than 100% of the tax paid or assessing the tax at the highest marginal rate and excluding the income at the individual level or providing a nonrefundable credit.

Additionally, providing this federal tax savings opportunity that most other states have enacted could prevent portions of a state’s tax base from relocating to a more tax-friendly state, which has been trending since the start of the Covid-19 pandemic.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Luke Lucas is an associate director of state and local tax services with Berkowitz Pollack Brant.

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