During the 2020 Session of the Maryland General Assembly, Senate Bill 523 was passed, which authorized pass-through entities (PTEs) to elect to be taxed at the entity level for state income taxes. The bill took effect on July 1, 2020. This is intended to be a workaround for owners whose individual state and local tax deductions have been capped at $10,000 by the Tax Cuts and Jobs Act (TCJA).
Before this law change, Maryland PTEs who had a nonresident owner were required to withhold tax on their share of the PTE’s income. However, this was considered to be the withholding of tax on behalf of the nonresident owner and not a tax liability of the PTE itself and, therefore, was not considered a deduction to the PTE.
The election is effective for tax years beginning in 2020. It would allow PTEs to pay and deduct the Maryland income tax liability created by business income on behalf of all owners rather than being paid and potentially not deducted by the owners at the individual level due to the State and Local Tax (SALT) limitations imposed by the Tax Cuts and Jobs Act (TCJA). PTEs that elect to pay taxes will pay a tax rate of 8.25% for corporate PTE members’ shares of taxable income, and these corporations will receive a credit for the taxes paid. PTEs that elect to pay taxes for individual PTE members will pay the tax at the highest marginal state income tax rate of 5.75% and the lowest county tax rate (2.25% in 2020), for a total of 8%, and these individuals will receive a credit for the taxes paid.
Once the election is made for 2020, you may need to adjust individual Maryland estimated tax payments.
Important: Will the IRS issue guidance to negate this workaround? It’s possible, however they have not issued any guidance regarding the Connecticut entity level law, enacted in 2018, which is the law that Maryland modeled theirs after. The availability of this benefit remains subject to further federal legislation and guidance.
Information still to come
- How will this election be made by the entity?
- Is this election a permanent or will it need to be made annually?
- Will PTE estimated tax payments be required?
- How will composite returns work with this new election?