By: Amy Hilfiker
On November 18, 2021, the North Carolina legislature enacted Senate Bill 105 (S.B. 105), which included a new elective pass-through entity tax (“PET”) and joined an extensive list of states that have established these elective entity-level tax regimes for pass-through entities as a workaround to the $10,000 cap on the amount of state and local taxes that individual taxpayers may deduct on their Federal tax returns.
S.B. 105 allows eligible partnerships and S Corporations to elect to pay an entity-level state income tax for taxable years beginning on or after January 1, 2022. Eligible pass-through entities do not include publicly traded partnerships, or any partnership with a partner that is not an individual, estate, or taxpayer that would otherwise be a qualified S-Corporation shareholder under the Internal Revenue Code.
The NC PET Tax election is made annually on the entity’s timely filed (including extensions) return for the tax year, and once made on an original return, may be revoked with an amended return filed before the regular or extended due date for the same tax year. The PET Tax is calculated at the state’s individual income tax rate for the tax year at 4.99% for 2022.
Owners of an electing pass-through entity would then be eligible to deduct their share of income subject to the PET when computing their NC personal income tax. The key benefit to the owner is that under current federal law, a pass-through entity that elects to pay state income tax at the entity level may generally deduct the full amount of its state income tax on the pass-through entity’s federal income tax return, therefore, working around the owner’s federal itemized tax deduction limitation.
The taxed pass-through entity is required to pay tax when the return is due. If the taxed pass-through entity does not pay the tax shown due on the return, the North Carolina Department of Revenue must issue a notice of tax collection. If the tax is not paid within 60 days of the notice of collection, the members of the taxed pass-through entity may not exclude the income or loss attributable to them and will be issued a notice of proposed assessment.
Department of Revenue Guidance
In late April 2022, the North Carolina Department of Revenue released “Important Notice Regarding North Carolina’s Recently Enacted Pass-Through Entity Tax”, which provided answers to frequently asked questions related to the implementation of the NC PET. In addition to summarizing the provisions of the NC PET, the Notice provides additional guidance including general information, owner-level reporting implications, and information on the credit for income tax paid to another state.
An electing pass-through entity that reasonably expects a North Carolina income tax liability of at least five hundred dollars ($500) is required to pay quarterly estimated tax payments in the same manner as a C corporation. The installments are generally due on or before the 15th day of the fourth, sixth, ninth, and twelfth months of the taxable year (for calendar year filers, April 15, June 15, September 15, and December 15). For 2022, North Carolina will not subject electing taxed pass-through entities to interest for underpayment of estimated income tax.
If your pass-through entity operates in other states, there are similar opportunities to utilize this tax savings mechanism in other jurisdictions as well. Many pass-through entities will benefit from making the election(s), as pass-through owners will be able to reduce federal taxable income for the entity level tax payment. However, there will be cases where the taxed pass-through entity election will not create the expected benefit, and guidance in this area is still developing.
If you have any questions or would like our assistance with determining your eligibility and the potential benefit of making a pass-through entity tax election, please contact your HPG tax advisor.