On November 18, 2021, the North Carolina General Assembly passed legislation that enacted a pass-through entity tax (PTET) for qualifying partnerships and S-Corporations filing North Carolina income tax returns as a workaround to the federal state and local tax deduction limit on an individual’s federal income tax return. North Carolina Department of Revenue released FAQs in April 2022 with more guidance to come. As the end of 2022 is within sight, pass-through entities need to consider whether any action is required by year-end.
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.
The pass-through entity tax is calculated by multiplying taxable income of the taxed PTE by the North Carolina individual income tax rate (4.99% for 2022). Taxable income or loss of the taxed PTE is computed by adding each partner’s or shareholder’s share of income or loss and each partner’s or shareholders share of NC decoupling adjustments (e.g., bonus depreciation). Taxable income does not include separately stated deductions such as charitable contributions and Section 179 depreciation, which are deductions that are ultimately determined on the partner’s or shareholder’s individual tax returns.
Pass-through income, including decoupling adjustments, are reported on the Partner’s or Shareholder’s North Carolina tax return. Pass-through income taxed on the pass-through entity’s tax return is deducted on the shareholder’s or partner’s North Carolina individual income tax return to the extent the income was reported on the individual’s federal income tax return.
Entities that make the NC PTET election that expect an income tax liability of more than $500 are required to make estimated tax payments in quarterly installments. For calendar year filers, payments are due on the 15th of April, June, September, and December. For 2022, an electing entity will not be subject to interest for underpayment of estimated tax. NC-429 PTE is used to remit pass-through entity estimated income tax payments.
A Taxed PTE is allowed a North Carolina tax credit for income taxes paid by the entity to another state on the same income that is taxed by North Carolina. The North Carolina resident partner or shareholder of a Taxed PTE is not allowed a tax credit on the individual’s NC income tax return.
If a Taxed PTE for North Carolina purposes is not a taxed PTE in another state, the North Carolina resident partners or shareholders may be allowed a credit for the tax paid to the other state.
If the pass-through entity does not elect to be a Taxed PTE in North Carolina and elected to be a Taxed PTE in another state, any credit for taxes paid to the other state must be claimed on the owner’s individual income tax return. For shareholders of an S Corporation, the tax credit can be claimed on their North Carolina individual income tax return unless the other state measured the income of the resident shareholders by the income of the S Corporation. For partners in a partnership, no credit can be claimed on the partner’s individual North Carolina income tax return.
Nonresident owners that do not have any other NC-source income are not required to file an individual North Carolina return if the pass-through entity elects to be a Taxed PTE and the pass-through entity pays the tax due.
All factors should be viewed in their entirety for consideration for whether to make the election. Contact the professionals at Gilliam Bell Moser LLP for tax advice that can help you determine if your pass-through entity qualifies and if an NC PTET election is an appropriate tax planning strategy. If you engage with multiple tax preparers and advisors, we encourage communicating with them to ensure understanding and to help coordinate a plan of action across all entities.