Kentucky Pass-through Entity Tax (PTET) Update
Published March 24, 2023
On Friday, March 24, Kentucky Governor Andy Beshear signed House Bill 360 into law, notably approving Pass-Through Entity Tax (PTET) legislation in Kentucky. Neighboring state, Indiana, recently passed their own PTET bill on February 27. This legislation allows PTEs (pass-through entities) to elect to pay Kentucky income tax at the entity level on the pro rata share of income allocated to individual PTE owners. Kentucky taxpayers may take advantage of tax savings by making the election with their 2022 PTE returns.
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 PTE the option to pay (and expense) state and local tax at the entity level, creating a work around to this Federal $10,000 limitation.
An illustration of what this could mean for a taxpayer:
Company A is an S Corporation with one Kentucky resident shareholder. Company A has $100,000 of Kentucky-sourced income. Without a PTET law in place, $100,000 is reported to the shareholder on his or her Company A K-1, creating Kentucky individual income tax of approximately $5,000 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 $5,000 is paid and expensed by Company A. This reduces Federal taxable income reported to the shareholder on the Company A K-1 to $95,000. This $5,000 reduction in Federal taxable income could save the taxpayer approximately $1,500 in Federal tax (assuming a 30% Federal marginal tax rate).
This development is exciting news for Kentucky-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 Kentucky must update forms and processes to allow for PTET, the PTET election is not expected to be available until later this year. Additionally, questions remain regarding how to formally elect, what type of owners may be eligible to opt-in, how to make payment towards the PTET, how taxpayers that have previously made individual income tax estimates are impacted, and so on. 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.