SALT Strategies

New York’s Pass-through Entity Tax – Potential Lower Federal Tax Benefits to S Corporation Shareholders

PTET LI1 - New York’s Pass-through Entity Tax – Potential Lower Federal Tax Benefits to S Corporation Shareholders

New York’s Pass-through Entity Tax (PTET) may result in significantly lower Federal tax benefits for certain electing S corporations. The potential Federal tax benefits of the New York State (NYS) PTET for resident shareholders of S corporations with low NYS Business Apportionment Percentages (BAP) may be significantly lower than initially expected. Why? The PTET provisions’ definition of taxable income for electing partnerships/LLCs {“partnerships”} in the 2021-22 NYS Budget is substantially broader than the definition of pass-through entity (PTE) taxable income for S corporations.

As detailed below, this difference may result in significantly lower Federal tax benefits from the PTET for New York resident shareholders of S corporations with less than 100% NYS BAPs than those of New York resident partners of partnerships with similar NYS BAPs.

PTE Tax Definition of Taxable Income for Partnerships Versus S Corporations

Potential Beneficial Treatment for Partnerships with Less Than 100% New York BAP

The good news is that the PTET, as adopted by S2509 C (§ 860 (h)(1)), expanded the definition of taxable income for eligible electing partnerships. It defines taxable income for partnerships as follows:

(1) In the case of an electing partnership, the sum of

(i) all items of income, gain, loss, or deduction derived from or connected with New York sources to the extent they are included in the taxable income of a non-resident partner subject to tax under article twenty-two under paragraph one of subsection (a) of section six hundred thirty-two of this chapter; and
(ii) all items of income, gain, loss, or deduction to the extent they are included in the taxable income of a resident partner subject to tax under article twenty-two of this chapter.

This definition for partnerships has broadened the PTET taxable income of partnerships. This is especially beneficial with respect to New York resident partners of partnerships with low or less than 100% NYS BAP. For such New Yorkers, the partnership’s PTET taxable income is determined on “all items of income, gain, loss, or deduction to the extent they are included in the taxable income of a resident partner,” – i.e. as if the partnership had a 100% BAP regardless of the partnership’s NYS BAP!

A key consideration for electing partnerships that have resident and non-resident New York partners will be an analysis of whether the partnership agreement requires modification to address the PTET taxable income definition and its ramifications on allocation of income.

Inconsistent Treatment for Electing S Corporations with Less Than 100% New York BAP

The disconcerting issue is that the § 860 (h) definition of PTET taxable income for partnerships does not apply to S corporations that have less than 100% NYS BAP.

§ 860 defines taxable income with respect to S corporations in (h)(2) as the sum of:

(i) all items of income, gain, loss, or deduction derived from or connected with New York sources to the extent they would be included under paragraph two of subsection (a) of section six hundred thirty-two of this chapter in the taxable income of a shareholder subject to tax under article twenty-two of this chapter.

The aforementioned definition of PTET taxable income is conceptually and significantly distinguishable from the calculation of PTET taxable income applicable to partnerships set forth in § 860 (h)(1) as follows:

1. The PTET definition of taxable income for S corporations does not bifurcate the calculation into two calculations as it does for partnerships – i.e. one for income attributable to New York non-resident owners based on New York BAP and one for New York resident owners based on the amount of income from the PTE included in the resident owners’ personal income tax return.
2. Taxable income for S corporations is specifically based on New York Sourced Income. § 860 (h)(2) states that taxable income for S corporations is the sum of (i) all items of income, gain, loss, or deduction derived from or connected with New York sources to the extent they would be included under paragraph two of subsection (a) of section six hundred thirty-two of this chapter in the taxable income of a shareholder.

By § 860 (h)(2) referencing § 632 Non-Resident Partners and Electing Shareholders of S Corporations, it appears that S corporation PTET is determined by the S corporations’ New York sourced income. § 632(a)(2) states in part “In determining New York source income of a non-resident shareholder of an S corporation …. there shall be included only the portion derived from or connected with New York sources of such shareholder’s pro rata share of items of S corporation income, loss and deduction entering into his federal adjusted gross income, … as such portion shall be determined under regulations of the commissioner consistent with the applicable methods and rules for allocation under article nine-A of this chapter,…”

This definition’s reference to § 632 would appear to require that S corporations that have less 100% NYS BAP will determine their PTET by the S corporations’ NYS BAP. This will result in such S corporations having a lower PTET taxable income and their resident New York shareholders will therefore receive a limited Federal tax deduction for said NYS PTET.

The Take Away – Potentially Beneficial, Still Developing and Caveat Emptor

Was the distinction between partnerships and S corporation intentional? To date, my research has not identified any insights as to why the State’s PTET provisions appear to result in significantly different PTET taxable income for S corporations as compared to similarly situated partnerships. Is it an unintended oversight resulting from changes to the State’s PTET provisions? Or was NYS concerned that if the PTET definition of taxable income for electing S corporations mirrored that of partnerships, it may trigger Federal S corporation tax issues?

The NYS PTET continues to present significant technical as well implementation issues. It is increasing apparent that PTE owners and their tax advisors considering the New York PTET, as with the New Jersey BAIT, should tread carefully and thoroughly analyze the benefits as well as the consequences of making a PTET election. Their analysis will be sensitive as well as dependent on each PTE’s type, the PTE owners’ New York resident status, and in the case of S corporations, the PTE’s New York BAP.


Read: New York’s Budget Decouples From Federal Opportunity Zone Tax Benefits – Is It a Big Swing and Miss for New York Taxpayers?

Read: Batter up – The NYS 2021-22 Budget – Is It a Home Run or Strike Out for New York State Taxpayers and Businesses?