Updated August 14, 2024
What is a Pass-through Entity Tax?
The Tax Cuts and Jobs Act of 2017 (TCJA) imposed a $10,000 limitation on the state and local tax (SALT) deduction for individuals who itemize deductions on their federal income tax return for tax years beginning after 2017 and before 2026. In response, many states have enacted a mandatory or elective pass-through entity (PTE) tax as a workaround to the SALT cap.
The PTE tax allows eligible pass-through entities to deduct state taxes at the entity level for federal tax purposes, while providing a credit, deduction, or income exclusion to the passthrough entity owners for state income tax purposes. In November 2020, the Internal Revenue Service (IRS) issued notice 2020-75, confirming that state taxes paid through a PTE are exempt from the SALT cap of $10,000.
As of May 14, 2024, there were 36 states (including Maryland and Virginia) and one locality that enacted a PTE tax, effective for 2021 (or earlier). The District of Columbia, which has an owner-level personal income tax on PTE income, has not yet proposed or enacted PTE taxes.
District of Columbia
• D.C. has not yet proposed or enacted a PTE tax.
• D.C. allows the resident individual to claim a credit against such resident’s D.C. income tax liability for the PTE tax paid on such resident’s behalf to other state in the same manner as if these taxes were paid by the individual directly. D.C. residents may not claim the credit for a franchise tax, license tax, excise tax, unincorporated business tax, occupation tax, or any tax so characterized by the other taxing jurisdiction.
Maryland
- A qualifying PTE (partnerships, S corporations and LLCs) may elect to pay tax at the entity level rather than at the level of the members of the entity.
- The tax rate is 8% on the Maryland taxable income for its members who are individuals and 8.25% for its corporate members.
- Applicable to tax years 2020 and later.
- Form 511 (Pass-through Entity Election Income Tax Return) is used by an Electing PTE to file an income tax return for a specific tax year or period and to remit Electing PTE tax paid with respect to all members’ distributive or pro rata shares of income. By using this form, the PTE acknowledges that it has made the election for the taxable year with its first payment (estimated Form 510/511D, extension Form 150/511E , or with this Form 511).
- Two credits for the resident PTE members:
- Credit for their distributive share of the PTE tax paid by the entity. If the member’s Maryland tax liability is less than the amount of the credit, the excess is refunded to the member.
- Credit for state income tax paid to other states, including by the PTE. However, this credit cannot exceed the member’s share of the pro rata tax paid by the PTE.
- An Electing PTE is not permitted to file a composite Maryland income tax return Form 510C on behalf of qualified nonresident individual members.
Virginia
- A qualifying PTE can make an annual election to pay an elective income tax (PTET) at entity level. However, only the pro rata or distributive share of income, gain, loss or deduction attributable to eligible owners is subject to the PTET. As such, the amount attributable to non-eligible owners is not subject to PTET.
- Tax rate is 5.75% at the entity level.
- Applicable to tax years beginning on or after Jan. 1, 2021, but before Jan. 1, 2026.
- For tax years beginning on or after Jan. 1, 2022, but before Jan. 1, 2026, the annual PTET election can be made by:
1) filing the entity’s PTET return (Form 502PTET) on or before the extended due date for the taxable year, or
2) making an estimated payment of PTET for the taxable year, or
3) making an extension payment of PTET for the taxable year. - An Electing PTE is not permitted to file composite return (Form 765).
- An eligible owner may claim a refundable PTET credit against their Virginia individual or fiduciary income tax. Eligible owners must wait until the electing PTE issues the Schedule VK-1 before claiming the PTET credit.
- VA legislation allows taxpayers to claim a credit on their individual income tax return for certain taxes paid by a PTE under another state’s substantially similar PTE tax structure for taxable years 2021 through 2025. This new provision of the legislation overrules prior legislation which generally denied a credit for a tax paid to Maryland under the state’s elective pass-through entity tax. It does not apply to other entity taxes, such us any non-elective franchise, privilege, business, license, occupation, excise, or unincorporated business taxes. A Virginia resident cannot claim a credit for the DC Franchise tax paid.
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Councilor, Buchanan & Mitchell (CBM) is a professional services firm delivering tax, accounting and business advisory expertise throughout the Mid-Atlantic region from offices in Bethesda, MD and Washington, DC.
