Indiana Pass-through Entity Tax (PTET) Update 

Published February 27, 2023

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The Tax Cuts and Jobs Act (TCJA), passed in 2017, limited taxpayers to a $10,000 maximum deduction of state and local taxes for Federal tax purposes. This ‘SALT limitation,’ as it would be widely known, impacted taxpayers that itemize deductions at the Federal level.  A growing number of states have passed legislation allowing pass-through entities the option to pay (and expense) state and local tax at the entity level, creating a work around to this Federal $10,000 limitation.

Currently, approximately 30 states have enacted Pass-Through Entity Tax (PTET) legislation in some form.  On February 22nd Indiana became the latest state to pass a PTET bill with Senate Bill 2, which would permit partnerships and S Corporations to elect to pay Indiana state tax at the entity level, resulting in an increased state tax expense for entities.  In an added wrinkle, SB2 makes the PTET effective retroactive for the 2022 calendar year.

An illustration of what this could mean for a taxpayer:  Company A is an S Corporation with one Indiana resident shareholder. Company A has $100,000 of Indiana-sourced income.   Without a PTET law in place, $100,000 is reported to the shareholder on his or her Company A K-1, creating Indiana individual income tax of approximately $3,000 at the shareholder level.  For Federal purposes, the shareholder likely sees no benefit from this state tax liability, either because they’ve already reached the SALT limitation cap or because they take the standard deduction.

By electing to pay PTET at the entity level, the $3,000 is paid and expensed by Company A.  This reduces Federal taxable income reported to the shareholder on the Company A K-1 to $97,000.   This $3,000 reduction in Federal taxable income would save the taxpayer approximately $1,000 in Federal tax.

This development is exciting news for Indiana-resident business owners and can result in significant Federal tax savings.  However, the retroactive nature of the Bill creates a host of uncertainty in the middle of 2022 tax return filing season.   Because Indiana must update forms and processes to allow for PTET, the PTET election is not expected to be available until approximately mid-August 2023. Additionally, questions remain regarding how to formally elect, how to make payment towards the PTET, how taxpayers that have previously made individual income tax estimates are impacted, and so on.  The Bill is estimated to result in $50 million in Federal tax savings for Indiana small business owners, so taxpayers that may benefit from electing PTET would be wise to wait for further guidance and extend their 2022 tax returns.

For more information, please reach out to your trusted MCM relationship contact.