Where individual, corporate, and passthrough entity taxation meet

By Mo Bell-Jacobs, J.D.; Bridget McCann, CPA; and Steve Wlodychak, J.D., LL.M.

Editor: Bridget McCann, CPA

By now, most practitioners are well aware of the annual limitation enacted by the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, in 2017 that limits the amount of state and local taxes individuals can deduct for federal income tax purposes to not more than $10,000 ($5,000 in the case of a married individual filing a separate return) (the SALT cap).1 No doubt most are also aware of the ensuing legislation at the state level to offer taxpayers a "workaround" to the SALT cap by enacting passthrough-entity-level taxes, which arguably impose the tax liability for owners of passthrough entities (PTEs) (such as partnerships, LLCs treated as partnerships, and S corporations) instead directly on the PTE.2

These new state PTE taxes essentially allow owners of PTEs to bypass the SALT cap by allowing their distributive share of the taxes to be paid by the entity at the entity level, as reported on their respective Forms K-1, since one exception to the SALT cap was the retention of the "trade or business" exception. Moreover, most should also be aware that after much silence and uncertainty, and almost three years after the TCJA's enactment, the IRS issued Notice 2020-75,3 stating its decision that PTE owners can deduct their share of the taxes paid by the entity, even if electing to be taxed at the entity level, and that it would be issuing proposed regulations to that effect.

As of this writing, the Biden administration has placed a hold on the enactment of all final regulations proposed by the Trump administration,4 and it is at this time unclear whether it will continue with the proposed regulations relating to the SALT cap. Regardless, what remains a hot topic of discussion, at least among state tax practitioners, is how beneficial any PTE-level tax will be.

Determining the benefit is going to be highly dependent upon each PTE's facts and circumstances, as well as those of its owners, both individuals and legal entities. In addition to considering state geography, however, an analysis will also need to take into account owner composition and could require practitioners to consider elements of individual, corporate, and PTE taxation. A few examples of this complex analysis are provided below.

The allowance of an individual credit for taxes paid by the entity

Individual multistate taxpayers are generally allowed an individual income tax credit in their resident state for individual income taxes paid in another state. As described above, state PTE taxes shift the liability for state taxes from the PTE owners to the PTE itself, providing a deduction for the state PTE tax from the distributive share of the owners' income. In those states that have enacted a PTE tax, individual owners can generally claim a proportionate share of the PTE tax paid as a credit against their state tax liability, with several exceptions. However, this mechanism may cause some owners to lose the credit for taxes paid in their resident state for the taxes paid by the PTE. Similar to how some states prohibit a nonresident income tax credit for the Texas franchise tax, some states may similarly deny a credit for an individual owner's share of the PTE tax paid in another state.

For example, the Rhode Island PTE tax law specifically explains that a similar tax imposed by another state on the owners' income paid at the entity level is allowed as a credit for taxes paid to another jurisdiction.5 Under New Jersey's PTE tax law, a resident taxpayer can claim a credit for his or her distributive share of the Connecticut PTE tax against a gross income tax liability.6 Alabama has historically embraced the concept of allowing a credit for taxes paid by residents indirectly through their ownership of interests in a PTE.7

To be clear, this will be an issue to consider in all states imposing a personal income tax, not just those that have themselves enacted these new PTE taxes. Pennsylvania, for example, has published guidance stating that certain entity-level taxes paid by S corporations are eligible for that state's resident credit for taxes paid to other states but that no resident credit is allowed for entity-level taxes paid by partnerships.8 It instructs that a resident credit is limited to income and wage taxes and, therefore, while an entity-level tax will generally qualify for Pennsylvania resident credit purposes, each state's entity-level tax must also be considered separately to determine its eligibility. The Pennsylvania guidance notes that in certain situations the resident credit for an entity-level tax may be adjusted.

Most states have not yet provided specific guidance; thus, some owners may have a higher state tax liability if a credit for taxes paid by a PTE under a state's SALT cap workaround regime is denied by the owner's resident state. From an owner's perspective, the loss of the resident state tax credit for taxes paid to another state in exchange for the increased federal state and local tax deduction above the SALT cap may ultimately be an increase in state, or even overall, tax liability.9

Parity among owners

Generally, in the states that have enacted PTE taxes for purposes of a SALT cap workaround, the tax rate imposed on the PTE is equal to the state's highest individual income tax rate. In many cases, PTE owners may already be subject to the state's highest individual income tax rate and, therefore, will not incur any additional liability simply because the tax is being assessed at the PTE level (other than, perhaps, not benefiting from the lower marginal rate schedule of the state in computing the potential tax liability, all of which is usually refundable when the individual owner files his or her own tax return).

However, there are notable scenarios to consider as more states enact the workarounds. In California's initial PTE tax proposal, no tax rate was listed.10 California's top individual tax rate is 13.3%, consisting of 12.3% of regular tax and an additional 1% for incomes exceeding $1 million — four percentage points higher than the state's 9.3% tax bracket that tops out at income over $599,016 for 2020 (for married filing jointly taxpayers).11 (A recent amendment to the initial California bill inserted a flat 9.3% rate.)12 If the proposal follows the PTE tax SALT cap workarounds enacted in other states by adopting the state's highest marginal personal income tax rate, some owners may pay more in California PTE tax estimated taxes during the year than they owe as an individual taxpayer (although the California PTE proposal includes a fully refundable credit for any excess PTE taxes paid compared to what would have been owed under the personal income tax).

Wisconsin did not enact a brand-new tax. Rather, in that state, an electing PTE can instead elect to be treated as a C corporation solely for Wisconsin income tax purposes and, thus, be subject to a flat 7.9% entity-level tax,13 compared to the progressive individual income tax rates, which top out at the highest marginal rate of 7.65% for married taxpayers filing a joint return with incomes over $351,310 in 2020.14

In New Jersey, the PTE tax rates are progressive and based on the sum of each member's share of distributive proceeds attributable to the PTE and not based on the total income of the entity itself.15 From a practical administrative perspective, if a nonresident owner of a New Jersey PTE also earns New Jersey-source income from outside of the entity, the withholding on the distributive share may lead to underreporting of New Jersey income.

Potentially exacerbating inequities, not every state requires unanimous consent of the owners to make an election to pay the state's PTE tax. As an example, New Jersey requires all owners to agree to the election, but Alabama only requires a vote or consent from certain owners to make the election.16

Whether an owner will be able to claim a credit for taxes paid, and how various states treat the tax on the entity, may ultimately result in disparate and unintended treatment of owners.

Electing entities should also consider the impact of the election on both individual and entity estimated payments. An entity that elects into the state's PTE workaround tax after the first or second quarterly estimated individual income tax payments were made may not be able to transfer those payments to the PTE's account. This could temporarily impact the cash flow of both the entity and the owners. Accordingly, PTEs should consider electing early in the year to mitigate overpayments of estimated taxes.

Corporate aspects for consideration

Each state has approached the enactment of its PTE tax in a different way, in some cases incorporating certain elements of other jurisdictions that were at the front of the pack, adding an "a la carte" feel to this genre of state tax. A few of the more unique aspects based on corporate concepts or impacting corporate owners are noted below.

New Jersey

New Jersey's historic treatment of partnerships is already a good example of the conflict between the differing tax interests and concerns of individuals compared to corporate owners. Under New Jersey law, partnerships are subject to the state's gross income (personal) tax statutes and regulations and not the state's corporate business tax law. New Jersey's law, however, requires partnerships to remit a nonresident partner tax (akin to a withholding tax in other states) that was implemented through corporate business tax reform in 2002. This is therefore calculated according to corporate business tax statutes and regulations. There are very limited circumstances where a partnership would not have to remit this tax for a nonresident partner.17

Preparing Forms NJ-1065, New Jersey Partnership Return, and NJ-CBT-1065, New Jersey Partnership Return Corporation Business Tax, requires two separate apportionment schedules to be completed. Form NJ-NR-A, New Jersey Gross Income Tax Business Allocation Schedule, applying gross income tax methodologies, is used for purposes of determining a nonresident partner's distributive share. The Schedule J, "Corporation Allocation Schedule," applying corporation business tax methodologies, is used for purposes of determining the nonresident partner's tax. There is often a disconnect between the amount of distributable share income that a nonresident partner is ultimately taxed on and the nonresident partner's share of tax that the partnership calculates and remits.

Many had hoped that the enactment of the state's PTE tax, which is called the business alternative income tax (NJ BAIT), would offer a "fix" for this disconnect under the law that preexisted the PTE tax; however, the nonresident partner tax problem remains unchanged. The New Jersey Division of Taxation has addressed the fact that the partnership is still responsible for remitting tax on behalf of its nonresident partners, via the FAQ section of its website: "The election made by a pass-through entity to pay the Pass-Through Business Alternative Income Tax at the entity level does not eliminate the requirement to file any other tax return or pay any other tax that is required by the pass-through entity, such as the NJ-CBT-1065."18 Therefore, calculating and remitting the NJ BAIT at the entity level will not absolve the partnership of also remitting nonresident tax for its partners.

S corporations considering making a NJ BAIT election should be aware that New Jersey is among a few states that require a state-specific S corporation election to be completed in a timely fashion.19 Without the separate New Jersey S corporation election, a corporation is treated as a C corporation for all New Jersey state tax purposes (i.e., both under the gross income tax (New Jersey's personal income tax) and the corporation business tax (its corporate income tax)). This may add an additional calculus for taxpayers when considering whether they want to qualify for the NJ BAIT. Also, if electing to calculate NJ BAIT, the S corporation must apply gross income tax (i.e., New Jersey's personal income tax) methodologies for sourcing income while, at the same time, for purposes of reporting the net pro rata share of S corporation income to owners, the S corporation will need to use corporation business tax methodologies.20 This would seem to create a disconnect similar to the historic one that exists for the nonresident partner tax purposes described previously.

From the perspective of C corporation owners, the distributive proceeds from the PTE will continue to be included in the entire net income of the corporation, and they would be entitled to a credit for their distributive share of the NJ BAIT tax paid by a PTE. Since New Jersey recently adopted mandatory unitary combined reporting for corporation business tax, corporate partners may need to consider if credits would be a shareable attribute.21

NJ BAIT is required to be calculated on every member's share of distributive proceeds including exempt members. An exempt member will have to claim a refund for its distributive share of the NJ BAIT paid by the PTE.22


California's proposed legislation for an elective PTE tax excludes partnerships that contain nonindividual owners from participating. California's S.B. 104 instructs that for purposes of electing to be taxed at the passthrough level, a qualified taxpayer's owners must be composed exclusively of individuals, fiduciaries, estates, and/or trusts.23 It also excludes taxpayers that are included in a combined reporting group, which could preclude certain S corporations from eligibility.24

New York

In Gov. Andrew Cuomo's original budget proposal of its proposed PTE tax legislation, New York would have excluded PTEs with corporate owners from electing into the PTE regime.25 At one point, a proposal from the New York business community to provide greater flexibility while still excluding the distributive share of corporate PTE owners' income from the PTE tax would have allowed for an alternative basis for calculating the PTE tax by only including the portion of the PTE's income that relates to individual taxpayer owners in the PTE tax base.


Like Wisconsin, Louisiana chose not to enact a new tax but simply to allow a PTE to elect to be subject to the state's corporate income tax as if it filed a C corporation return at the federal level and then calculate and pay a graduated tax.26 Rather than receiving a credit, the shareholders, members, or partners receive an exclusion for income that is taxed at the entity level. While there doesn't appear to be a specific prohibition for entities that have nonindividual ownership, only individual owners are allowed the income exclusion benefit.

The impact of audit adjustments on the entity versus the individual

Potentially adding another element of complexity will be the way in which states address the new federal partnership audit rules. The disconnect between how the IRS now audits partnerships,27 with a default of assessment and collection at the entity level and election to "push out" payment of assessments to partners, and how states will account for adjustments borne from those examinations is already likely to sow confusion.

Although the Multistate Tax Commission (MTC) has developed and circulated a model uniform statute for states to adopt to conform to the new federal partnership audit regime, the majority of states still do not appear to have made any legislative changes that would adjust for the implications of the change in the federal partnership audit regime.28 Now layer in the fact that partnerships may be considering electing to be taxed at the entity level in certain states. Multistate partnerships may be encountering a wide variety of scenarios on audit due to the lack of uniformity. It is likely that a multistate partnership that has adjustments from a federal examination at the entity level will then have to account for those changes in both (1) states where they are not able to be, or do not elect to be, taxed at the entity level; and (2) states where they are either required to be or elect to be taxed at the entity level. In either case, those states may not yet have a similar process to the IRS to be able to collect at the entity level nor will those states' processes necessarily resemble one another. One could imagine the additional administrative burden these different scenarios will create when managing the audit process, especially where in some cases there may be changes in ownership or residency from year to year. It is already on track to be a convoluted process, and the election into a state PTE tax regime potentially adds a permutation for partnerships to consider.


While taxpayers may rely on the notice issued by the IRS in the meantime, proposed regulations have yet to be released. Also, given the recent change in presidential administrations and legislators, it is possible that a Democratic push to repeal the SALT cap could garner more support, thus eliminating the rationale for the state PTE taxes. In addition to the eight states that have enacted PTE taxes that became effective on or after Jan. 1, 2018, as of this writing the authors are aware of at least a half-dozen states that have discussed or proposed similar taxes.

Considering the complexity and uncertainty surrounding the practical application of newly enacted state PTE taxes, practitioners may be of most help to their clients by encouraging them to proceed cautiously and deliberately. The states that have adopted PTE workaround taxes are just beginning to consider guidance and regulations to address some of the many unknowns with these regimes. As demonstrated by the few examples discussed above, electing into a state's PTE tax regime may not serve all owners equally, could increase overall tax liability, and could have adverse effects on nonresident individual owners whose own state law will not provide an offset for the taxes otherwise deductible at the individual level. Moreover, a PTE with one or more corporate owners should carefully assess the overall implications of these regimes.

Without a modeling exercise, it may be difficult for practitioners and clients to appropriately consider the impact of electing into a state's PTE regime, considering all of the potential permutations that can exist depending upon the owner demographics and both the PTE's geographic footprint as well as each owner's.

Practitioners may wish to temper client expectations. Electing to be taxed at the entity level is not just as simple as filing a few different forms by the deadline. Research, modeling, planning, and analysis work should all take place prior to making an election into any state's PTE regime. Certain states make such elections binding until rescinded while others may require an annual election. These differences will need to be considered and tracked by state. In some cases, an annual review of facts or a change in position may be required.

Practitioners assisting clients should begin having discussions with PTEs and their owners, encouraging them to engage professional advisers to perform the services well in advance of the election deadline. Those who already assist clients with compliance should guard against "scope creep" by considering if separate statements of work to properly capture additional fees are warranted.

How much of a benefit these state PTE tax workarounds will ultimately yield in federal tax benefits will depend not only on the states in which the PTE does business but also the composition of its owners. Varying tax rates and the ultimate impact of the credit for taxes paid both against the state personal income tax of the state in which the PTE tax is levied as well as, in the case of individual owners, their state of residence may determine whether an electing PTE's aggregate additional state tax burdens and those of its owners exceed the federal tax savings of opting into any state's PTE tax workaround.  


1TCJA, §11042 (codified at Sec. 164(b)(6)).

2AICPA position paper on state passthrough-entity-level tax implementation issues, available at www.aicpa.org; AICPA state passthrough-entity-level tax implementation issues one-pager, available at www.aicpa.org; and map of states with passthrough-entity-level taxes enacted after TCJA, available at www.aicpa.org.

3IRS Notice 2020-75

4See Ronald A. Klain, assistant to the president of the United States and the chief of staff, Regulatory Freeze Pending Review (Jan. 21, 2021) (available at www.whitehouse.gov).

5R.I. Gen. Laws §44-11-2.3(e).

6N.J. Div. of Tax., Pass-Through Business Alternative Income Tax Act — FAQ, available at www.state.nj.us.

7The appropriate way to calculate the amount of the credit for taxes paid to other states for Alabama personal income tax purposes was previously the subject of much debate and ultimately was litigated. See Moody v. Alabama Dep't of Rev., No. Inc. 15-797 (Ala. Tax Trib. 9/29/16). Following the ruling in Moody, subsequent legislative changes enacted in 2018 codified the Alabama Department of Revenue's rule requiring an additional limitation not permitted by the original statute. See Ala. Code §40-18-21(a)(3) (added as an amendment by 2018 Ala. Leg. Acts 465 [2018 AL HB384], signed by the governor on March 28, 2018).

8Pa. Dep't of Rev., Credit for Entity Level Tax Paid by Pass-Through Entities (Answer ID: 3618) (Jan. 31, 2019, updated Jan. 13, 2021) ("The PA resident credit can only be claimed for an ELT [entity-level tax of another state] imposed upon a PTE treated as an S Corporation for PA income tax purposes. It cannot be claimed by other types of PTEs (partnerships and LLCs classified as partnerships)" (emphasis added) (available at revenue-pa.custhelp.com).

9Wlodychak, "IRS Just Raised State Taxes for Multistate Passthrough Entity Owners," 98 Tax Notes State 1159 (Dec. 14, 2020).

10See Cal. S.B. 104 (2021), §2 (adding Cal. Rev. & Tax Code §19900(a) ("[A] qualified taxpayer [i.e., a PTE] doing business in [California], as defined by [Cal. Rev. & Tax Code] Section 23101, and required to file a return under [Cal. Rev. & Tax Code] Section 18633, may elect to annually pay an elective tax according to or measured by its net income computed at the rate of _____ percent [blank in original] upon the basis of its net income for the last preceding taxable year" (emphasis added) (as introduced Jan. 5, 2021), available at leginfo.legislature.ca.gov).

11See Cal. Franchise Tax Board, 2020 Instructions for Form 540, Personal Income Tax Booklet, 2020 California Tax Rate Schedules, Schedule Y (Married/RDP Filing Jointly), available at www.ftb.ca.gov.

12See 2021 California S.B. 104, Sec. 2 (adding Cal. Rev. & Tax Code Section 19900(a)(1)) (amended in California Senate March 9, 2021) (available at leginfo.legislature.ca.gov (last accessed March 31, 2021)).

13Wis. Dep't of Rev., Pass-Through Entity-Level Tax: Partnership Determining Income and Computing Tax (Q&A No. 2), available at www.revenue.wi.gov.

14Wis. Dep't of Rev., Tax Rates — Q&A No. 1, What are the individual income tax rates?, available at www.revenue.wi.gov.

15See N.J. Rev. Stat. §54A:12-3(b)(2).

16Compare Alabama 2020 H.B. 353 §3(d) ("Both the election to become an Electing Pass-Through Entity and the revocation of that election shall be accomplished by a vote by, or written consent of, the members of the governing body of the entity as well as a vote by, or written consent of, the owners, members, partners, or shareholders holding greater than 50% of the voting control of the entity") to N.J. Rev. Stat. §54A:12-3(b)(1) ("The election to pay tax at the entity level is available if consent is made by each member of the electing entity who is a member at the time the election is filed or by any officer, manager, or member of the electing entity who is authorized, under law or the entity's organizational documents, to make the election and who represents to having such authorization under penalties of perjury.") Alabama's law thus requires a vote or written consent of the members of the governing body as well as a vote or written consent of owners holding greater than 50% of the voting control while New Jersey's law appears to allow the PTE tax election effectively to be made at the individual member's level (by negative implication if a member refuses to provide the consent, the PTE tax appears not to apply to that member's "distributive share" of the PTE's income).

17See N.J. Div. of Tax., Form NJ-1065E 2020, New Jersey — Corporate Partner's Statement of Being an Exempt Corporation or Maintaining a Regular Place of Business In New Jersey, available at www.state.nj.us.

18N.J. Div. of Tax., Pass-Through Business Alternative Income Tax Act — PTE FAQ — Nonresidents (Q&A No. 1), available at www.state.nj.us.

19See N.J. Rev. Stat. §54:10A-5.22 (election as a New Jersey S corporation).

20See N.J. Div. of Tax., Pass-Through Business Alternative Income Tax Act — PTE FAQ — Nonresidents (Q&A No. 3), available at www.state.nj.us. However, when completing the CBT-100-S, taxpayers are instructed to use Schedule J and corporation business tax rules to determine each shareholder's share of New Jersey allocated S corporation income or loss. 

21See N.J. Rev. Stat. §54:10A-5.43(c) ("If the pass-through entity is unitary with both the corporate member and the member's combined group filing a New Jersey combined return for which the corporate member is included as a member . . . the credit shall be shareable.").

22N.J. Div. of Tax., Pass-Through Business Alternative Income Tax Act — PTE FAQ — Refunds (Q&A No. 1), available at www.state.nj.us.

23See Cal. S.B. 104, §2 (adding Cal. Rev. & Tax Code §19902(a)(2)).

24Id. (adding Cal. Rev. & Tax Code §19902(b) ("(b) 'Qualified entity' shall not include taxpayers permitted or required to be in a combined reporting group").

25See 2021 N.Y. A3009/S2509, Part C, §1 (adding N.Y. Tax Law Sec. 860(a) (defining "eligible partnership" for purposes of the NY PTE tax as "... any partnership as provided for in [IRC Section] 7701(a)(2) ... that consists solely of partners who are individuals."); see also same amendment adding N.Y. Tax Law Sec. 860(b), providing an identical individual ownership restrictions for an "eligible S corporation" (which seems to be overkill considering that for both federal and New York tax law purposes, an S corporation cannot have a corporate shareholder in any case) (available at www.nysenate.gov (last accessed March 31, 2021)).

26See La. Rev. Stat. §47.297.14.

27The Bipartisan Budget Act of 2015, P.L. 114-74, adopted new rules to replace TEFRA effective for years beginning after Dec. 31, 2017. See also Sherr, "Why States Should Adopt the MTC Model for Federal Partnership Audits," 51 The Tax Adviser 196 (March 2020), available at www.thetaxadviser.com/issues/2020/mar/multistate-tax-commission-federal-partnerships.html

28See Multistate Tax Commission, Model Uniform Statute for Reporting Adjustments to Federal Taxable Income and Federal Partnership Audit Adjustments DRAFT — With Technical Correction as of November 2020 and Additional Note for States Adopting the Model (rev. Nov. 2020) (available at www.mtc.gov).



Bridget McCann, CPA, is managing director of State Tax at Grant Thornton LLP in the Philadelphia area. Mo Bell-Jacobs, J.D., is a senior manager with RSM. Steve Wlodychak, J.D., LL.M., is a retired principal and tax consultant for Ernst & Young LLP. Ms. McCann is the chair and Mr. Bell-Jacobs is a member of the AICPA State & Local Tax Technical Resource Panel. For more information about this column, contact thetaxadviser@aicpa.org.


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