Filing season for Hoosier business owners just got more exciting.
Update: on February 22, 2023, Governor Holcomb signed into law Senate Bill 2.
The Indiana legislature is creating its own version of March Madness for the 2023 tax filing season. Senate Bill 2 (SB2) is being fast-tracked in this year’s spring legislative session, and it will allow for many Hoosier business owners to benefit from a workaround to the federal State and Local Tax (SALT) limitation passed by the Tax Cuts and Jobs Act (TCJA) in 2017.
The SALT limitation under the TCJA was one of the more controversial provisions of the Act, which limited the amount of state and local taxes a taxpayer could deduct as an itemized deduction to $10,000. This limit applied to all state and local income taxes, real estate taxes on personal and vacation residences, and sales taxes incurred during the tax year. For many taxpayers, this resulted in a higher federal tax bill due to a much lower deduction.
Since this SALT limitation went into effect in 2018, many states have enacted laws to make an election to allow state income taxes on pass-through entities (PTEs) to be deducted at the entity level and not subject to the $10,000 limitation. PTEs, which include partnerships, LLCs and S Corporations, avoid this limitation if they file a separate tax return. Making the election allows them to deduct these taxes on the PTE return, as the amount reported on Schedule K-1 to the owners of those entities would have the state income taxes deducted already. This is commonly referred to as the “SALT workaround.” SB2 creates Indiana’s version of the workaround and impacts the 2022 tax year.
The Logistics of SB2
Because of the retroactive nature of SB2, the 2022 election cannot be made until March 31, 2023 at the earliest. For 2022 tax filings, PTEs and their advisors will need to determine whether they should make the annual election to pay the Indiana state tax at the entity level or continue to file as they have in the past, allowing the tax to be paid by their shareholders or partners. Additionally, PTEs must determine whether to file on time for 2022 or extend their returns to await final guidance from the Indiana Department of Revenue (IDR).
As previously stated, this is an annual election. PTEs are not required to make this election, and there are instances where it may not be beneficial to pay the state tax at the entity level. For example, PTEs with non-resident shareholders and PTE owners who offset Indiana income or losses to reduce their tax burden require more analysis.
Deciding Whether to Make the Election
We still expect many Indiana PTEs to make the election for 2022, and it will likely not impact their 2022 federal PTE return, due to the timing of this law being passed in 2023. However, for PTE’s 2022 Indiana return, we expect that once the tax is computed on the PTE income, the state income tax will be paid at the entity level and then reported to each shareholder or partner on Schedule K-1 as a credit. This credit will then be reported on the shareholder or partner’s personal Indiana tax return, Form IT-40, as an Indiana tax payment on their behalf. For 2022 returns, the tax can be paid with the originally filed or amended return. We do anticipate that this will cause some taxpayers to receive a refund of Indiana taxes, assuming they already have paid these taxes.
For 2023 and 2024 tax years, SB2 allows for estimated taxes to be paid at the entity level before year-end without penalty, assuming the estimate exceeds 50% of the tax imposed when the return is filed.
Impact of SB2
Next, please note that this election only impacts the Indiana state tax of 3.23% in 2022. County tax is not affected by Senate Bill 2 and will continue to be paid at the individual level.
When filing the federal return, PTEs that make the election for 2022 returns will likely see the actual deduction included in their 2023 tax return because of the timing of the payment. They will also likely get a deduction for the 2023 PTE tax payment should they choose to make an estimated tax payment prior to year-end.
SB2 is expected to be signed into law by the end of February. Impacted PTE partners and shareholders will then need to navigate the complexities of their personal tax situation with their tax advisors to assess whether this election will be beneficial for their 2022 tax returns. Additionally, PTEs that make the election will need to consider whether to file on time and amend it later or simply extend their Indiana return.
SB2 further revises filing statutes to allow Indiana residents to take a tax credit for other state taxes paid, retroactive to January 1, 2019. This change allows Indiana resident owners of PTEs that made substantially similar pass-through entity tax elections in other states to claim a credit against their Indiana state income taxes for their share of such taxes. Therefore, there may be some Indiana resident PTE owners that can file amended returns to claim credit for other state pass-through entity taxes that were paid at the PTE level. Please note that the 2019 calendar year closes for refund claim purposes on April 18, 2023, unless the individual owner’s 2019 Indiana return was extended. If this is the case, the due date is November 15, 2023.
As the Indiana legislature runs the picket fence to get SB2 enacted to help Hoosier businesses, there will be many questions. Don’t get caught watching the paint dry – please contact your Sikich tax advisor for the latest developments.