State Pass Thru Entity Tax Elections
This is one of the most underutilized tax savings strategies for small business owners.
Out of the 50 states in the US: 36 states (And NYC) have enacted a pass through entity (PTE) tax election. 3 states have proposed bills to implement this, and 9 states do not have personal income tax to begin with.
Meaning, unless you live in Delaware, North Dakota, or Washington DC, you likely can benefit immensely from this strategy, or you already do not pay state income tax to begin with.
Let me explain how it works:
Currently, there is a $10,000 limit on the state and local taxes (SALT) paid that you can deduct on your federal tax return. But it’s important to note that even then, your SALT taxes paid only benefit you if you are itemizing your deductions.
For example: Those who are married filing jointly, get a standard deduction of $27,700 on their federal tax return.
The only benefit that you would see from your SALT deduction would be to the extent that those taxes (which max out at a 10k deduction) along with other itemized deductions (there aren’t many of them), exceed $27,700.
So say your mortgage interest paid was $5,000
Property Taxes paid were $4,000
State income taxes paid were $7,500
And you donated $5,000 to charity.
These deductions would not benefit you at all since you were already getting a $27,700 standard deduction as a married filer.
However, most states have created an optional election which allows you to shift your state income tax (that results from your S-Corp or Partnership income) from your individual tax return to your business tax return.
This means that the taxes are now paid by the business, and these taxes are a deduction to the business.
So let’s use the example of a New York business owner (S-Corp) who made $150,000 this year. This would lead to around $8,000 in New York State Income taxes.
Likely, this taxpayer would not see any benefit on his federal tax return from paying this tax.
However, if he elects to shift the tax burden to his S-Corp, this becomes an $8,000 deduction for the business.
So clearly, the higher your business income, and the higher your state tax rate (I’m looking at you, New York and California residents), the more important this election becomes.
Every state has different rules surrounding the specifics, so make sure to discuss this election with your CPA to make sure you are staying compliant and optimizing this election for your situation.
