Business income from passthrough entities (PTEs) — S corporations and partnerships — is typically taxed when it passes through to the entity owners and is claimed on their personal income tax returns. But when the federal government put a $10,000 limit on individual itemized state and local tax (SALT) deductions in the 2017 Tax Cuts and Jobs Act (TCJA), many states, including Georgia, passed legislation to enable owners of PTEs to work around such limitations.
SALT Cap Workaround
Georgia enacted HB 149 to permit qualifying PTEs that file a partnership or S corporation tax return to claim a tax deduction for state taxes paid by the entity rather than having deductions limited or completely disallowed when taxes are paid by the individual entity owners. Essentially, HB 149 functions as a SALT cap workaround for tax years beginning on or after January 1, 2022. Under the legislation, entities can make an irrevocable election each year to pay Georgia income tax on their Georgia-sourced taxable income at the entity level at a rate of 5.75% before the income passes to the owners, much like a corporate income tax.
Eligibility and Timing of Election
To be eligible to make the election, all owners of the PTE must be eligible to be shareholders of an S corporation. Thus, a partnership with corporate, partnership or non-U.S. owners will not be eligible to make the election. The election to be taxed as a PTE is irrevocable, and it must be made annually by the due date for filing the S corporation or partnership return, including any extensions (which is more taxpayer friendly than other states that usually require the election to made by the original due date for the return). To make the election, consent must be received by all owners of the PTE. It is up to each electing PTE to decide how to obtain consent from its owners.
Impact to Georgia Shareholders and/or Partners
Shareholders and partners of electing PTEs will receive a Federal K-1 from the electing PTE that includes a tax deduction for Georgia taxes paid by the electing PTE. This, in turn, reduces federal income tax liability paid by each of the owners. In cases where the PTE makes the election, the Georgia-sourced PTE income being taxed will be excluded from the owner's individual Georgia income tax return. This can reduce the need for individual taxpayers to make Georgia individual estimated tax payments. However, by making the election, individual owners may also limit their ability to use credits or losses on their Georgia individual income tax.
Many other states have passed a similar SALT cap workaround for PTEs, some of which are in effect for tax years beginning in 2021.
Whether it makes sense for your passthrough business to make an election to pay state tax at the entity level depends on the facts and circumstances surrounding your business and its owners. As with any tax strategy, one size does not fit all, and any new strategy should be discussed with your trusted WBL tax advisor.