Tax planning is a year-round activity. As we approach the halfway mark of the year, it’s the perfect time to make sure you are well-prepared or begin planning for your projected year-end income. In that regard, Maryland Pass Through Entities (PTEs) should make sure they are considering the tax law change that went into effect in 2020.
In an effort to benefit Maryland taxpayers, the State Senate passed Bill 523 in May 2020, which states that pass-through entities now have the option to pay the tax imposed on a member’s distributive or pro rata share of income. Simply stated, this means that most PTEs, such as S-Corporations and Partnerships, may now directly pay tax on behalf of their resident members. This allows the state tax paid to become a deductible business expense, lowering the federal taxable income passed on to the members. In this article, we cover the implications of these tax changes for PTEs in the state of Maryland.
Implications for PTEs
Due to the Tax Cuts and Jobs Act of 2017 (TCJA), the amount of state and local income tax deductions an individual could take was limited to $10,000. This change reduced or eliminated the tax benefit that members of PTEs received by paying the entity tax directly on their personal tax returns. With the new tax law Maryland has enacted, the state is creating an opportunity for business owners that will now allow the tax to become an allowable business expense.
Here’s How the Tax Changes Will Work
When the PTE’s tax return is filed, the entity will elect to pay the resident members’ tax directly. This is an election that will be made each year. The entity will be taxed at 5.75 percent for state taxes and 2.25 percent for local taxes. Each member’s Schedule K-1 will then show their portion of income and tax that has been paid. Keep in mind that this information will still need to be reported on each individual’s tax return.
IRS Notice 2020-75 does state that the PTEs can only deduct the entity state tax in the year the payment is made. Therefore, if the election is made for 2020, the tax will be paid in 2021, and the owners will see the benefit on their 2021 tax filings. Owners may also see the business start to pay the estimated taxes, instead of those payments being made by them individually.
Due to the ongoing work to apply these changes to the tax returns, the state of Maryland has changed the tax filing deadline for these entities to July 15, 2021.
Planning for 2021
If you anticipate that your entity will have income in 2021, you will need to be prepared to pay timely quarterly estimated tax payments. While these payments can be adjusted quarterly based on income projections, they must be paid in 2021 to receive the business deduction in that year.
Be sure to keep in mind that Maryland tax payments will be added back to the state’s 2021 taxable income. Under 10-205 of the Tax-General article, PTE members who have elected this tax treatment must add back the amount of tax paid by the entity, which is attributable to the members’ share using Form 502LU.
We recommend discussing your specific situation with your tax advisor to see how this guidance could impact your PTE. Contact our state and local tax experts today.