On April 3, 2023, the North Carolina General Assembly passed legislation that enacted changes to the legislation passed in November of 2021 to the pass-through entity tax (PTET) for qualifying partnerships and S-Corporations filing North Carolina income tax returns. With the 2023 tax year coming to a close, individuals need to understand the updates and consider the impacts of the pass-through entity tax on their NC individual income tax returns.
NC Pass-through Entity Tax Election (NC PTET Election)
Gilliam Bell Moser’s NC Pass-through Entity Tax Election article covers the November 2021 legislation. To summarize, for tax years beginning on or after January 1, 2022, eligible pass-through entities can annually elect, on its timely filed (including extensions) North Carolina income tax return, to be taxed as a pass-through entity (Taxed PTE). Pass-through entity tax payments are deductible against federal pass-through income resulting in a workaround on the $10,000 cap on federal itemized deductions for state and local taxes.
Original legislation included:
- Taxed PTE election was a revocable election.
- Partnerships with partnership or S corporation owners were ineligible for the PTET election.
- PTE tax was calculated by multiplying NC taxable income of the Taxed PTE by the NC individual income tax rate.
- NC taxable income or loss for the Taxed PTE was calculated by adding each owner’s share of federal income or loss and each owner’s share of NC decoupling adjustments. Taxable income did not include separately stated deductions such as Section 179 depreciation or charitable contributions.
- PTE income and decoupling adjustments were reported on the owner’s NC individual tax return.
- Taxed PTE income was deducted on the owner’s NC individual income tax return to the extent it was included on the owner’s federal individual income tax return.
- NC resident S Corporation owners were allowed to claim a tax credit on their NC individual income tax return for entity level taxes paid to other states. Partnership owners were not allowed to claim a tax credit.
Retroactive changes passed by the North Carolina General Assembly include the following:
- Partnerships and S Corporations are now eligible owners for an electing partnership. See the GBM budget update article for additional eligible owners.
- Taxed PTE income only includes income for individual, trust, estate, and some tax-exempt organization owners for the entity level tax. For example, if you have an individual owner and a partnership owner in an electing taxed partnership, taxed partnership income includes the individual owner’s share of NC income not the partnership owner’s share of NC income.
- Nonresident withholding requirements apply to NC nonresident owners that are partnerships and S Corporations if the entity elects to be a taxed partnership.
Tax Credits (only for 2022 tax years)
- If PTET is not elected, NC resident partners may now claim a credit for income taxes paid by the entity to states other than NC. Only S Corporation NC resident owners were entitled to the tax credit previously.
- If PTET is elected, NC resident owners are not allowed to claim a credit for income taxes paid by the Taxed PTE to states other than NC on their NC resident individual income tax returns. Instead, a credit against the PTE tax can be claimed by the entity and NC resident owners may deduct their share of income to the extent it was included in the NC taxable income of the Taxed PTE.
Changes for tax years 2023 (and after) include the following:
- Updated calculation to Taxed PTE taxable income. Only NC sourced income is included in the Taxed PTE’s NC taxable income.
- PTE Owners may take a deduction for income taxed at the PTE level by NC and a deduction for income taxed at the PTE level by another state.
- In this circumstance, the credit for taxes paid to states other than NC cannot be claimed on the NC resident owner’s individual NC income tax return since the owners are eligible for the deduction for taxed PTE income.
- If the entity is not a Taxed PTE on NC, the owners are not entitled to the taxed PTE income to other states deduction. NC resident owners would be allowed to claim a nonrefundable credit on their share of the PTE taxes paid to other states on their NC individual income tax return.
- Annual Taxed PTE election on the NC tax return is irrevocable. In other words, once the entity elects to be a Taxed PTE on the entity’s timely filed tax return, the entity cannot elect out.
How does this affect North Carolina residents?
NC residents with ownership in passthrough entities with sourced income only from NC will see no change in their NC income tax returns for 2023 compared to 2022 where the entity elected to be a Taxed PTE.
- State income tax paid or accrued for the tax year by the Taxed PTE is allowed as a federal deduction according to its method of accounting on the Taxed PTE’s NC return.
- Taxed NC PTE income is deducted from NC income on the owner’s NC individual income tax return.
- Decoupling adjustments from the passthrough entity are reported as additions and/or deductions on the owner’s NC individual income tax return.
- Taxed PTEs are required to remit quarterly estimated tax payments if it reasonably expects to have NC income tax liability of $500 or greater for the tax year.
NC residents with ownership in passthrough entities with income sourced to NC and income sourced to states other than NC where entity level taxes are paid will see the following differences:
- Taxed PTE income sourced to NC is deducted from NC income on the owner’s NC individual income tax return.
- Separately, income subject to entity level taxes from states other than NC is deducted from NC income on the owner’s NC individual income tax return.
All factors should be viewed in their entirety for consideration for whether to make the Taxed PTE election and the impacts of making the election. Contact the professionals at Gilliam Bell Moser LLP for tax advice that can help you determine if a Taxed PTE election is an appropriate tax planning strategy. If you engage with multiple tax preparers and advisors, we continue to encourage communicating with them to ensure understanding and to help coordinate a plan of action across all entities.