Connecticut Enacts a Pass-Through Entity Tax; First Tax Payment is Due June 15, 2018
On May 31, 2018 Governor Malloy signed legislation establishing a new Pass-Through Entity (PTE) tax in Connecticut. The new tax is applicable to tax years beginning on or after January 1, 2018 and replaces the Composite Income Tax formerly applicable to PTE’s. A summary of the PTE rules follows:
- The PTE tax generally applies to entities taxed as a partnership or S corporations for federal income tax purposes, but does not include publicly-traded partnerships.
- The tax can be calculated using one of two methods:
- Normal method: Taxpayers compute the tax due, essentially based on the entity’s flow-through income, adjusted for Connecticut Personal Income Tax Modifications, then multiplied by the entity’s Connecticut apportionment factor and a 6.99% tax rate.
- Alternate method: Taxpayers compute tax based on the addition of two components:
- The “normal” method, as described above, and
- The additional non-apportioned income of CT resident individuals.
- “Members” (partners, members of LLCs treated as partnerships for federal income tax purposes, and
S corporation shareholders) receive a credit against the individual income tax or corporate income tax as follows:
- The credit is based on the member’s direct and indirect pro rata share of the tax paid.
- The amount of credit is equal to 93.01% of the tax paid by the PTE.
- The credit is fully refundable to individuals.
- The corporate credit may be carried forward until fully utilized and is not subject to limitation, but will be applied after all other applicable credits.
- A combined return can be filed by “commonly-owned” PTE’s upon election.
- “Commonly-owned” is defined as eighty percent of the voting control being owned, directly or indirectly, by a common owner(s), either corporate or noncorporate.
- In a tiered entity structure, the PTE tax is applicable at each tier (unless a combined return election is made).
- In calculating the PTE tax, a lower-tier entity should subtract its distributive income received from the upper-tier entity in which it is a member (or add its distributive loss received from the upper-tier entity).
- PTE’s that have losses may carryforward those losses until fully utilized.
Taxpayers should note that as opposed to the composite Income tax, which required only one annual tax payment, the PTE tax requires four quarterly estimated payments due on the fifteenth day of the fourth, sixth, ninth month of the current year, as well as the first month of the next taxable year. For calendar year taxpayers, the estimated payments are due:
- April 15
- June 15
- September 15
- January 15
The estimated tax payments are based on a calculation involving the lesser of 90% of the current year PTE tax, or 100% of the prior year tax if the prior year consisted of 12 months and a PTE tax return was filed. As 2018 is the initial year of the PTE tax, all quarterly estimates will be based on a calculation of 90% of the current year tax.
Additional guidance is expected any day from the Connecticut Department of Revenue Services (DRS). We believe DRS will allow taxpayers to make a “catch up” Quarter 1 payment with the Q2 payment due June 15, 2018. We also believe DRS will provide PTE’s the option to annualize their estimated payments to eliminate underpayment interest. A Q2 estimated tax payment coupon is available on the DRS website.
PTE’s should make Q2 estimated payments via check, mailed to DRS. Q3 estimated payments are expected to be taken electronically via the DRS Taxpayer Service Center.
We also expect DRS to allow individual members to recharacterize estimated income tax payments so that the payments are instead applied against the PTE’s estimated payment requirements. Regarding the recharacterization of these payments, please note:
- DRS anticipates providing additional information regarding the mechanism to recharacterize individual estimated payments by September 30, 2018.
- Many individual PTE members will no longer need to make estimated tax payments because of the PTE credit they receive. However, some members may still need to make estimated payments if they have income from other sources.
- Guidance regarding the cancellation of scheduled automatic estimated payments should also be forthcoming from DRS.
We will provide additional information as more guidance becomes available.
The PTE tax is the Connecticut General Assembly’s response to the federal $10,000 cap on the deduction for state and local taxes enacted as part of the federal Tax Cuts and Jobs Act of 2017. While the idea of an entity level tax and corresponding individual credit is straightforward, its implementation has created multiple questions and difficulties. The new law has made the affected entities’ tax compliance much more complex. Notably, the requirement to make quarterly estimates for the current year is problematic given the short amount of time until the June 15 estimate. In order to avoid potential penalties and interest for tax underpayments, it is critical that affected pass-through entities understand both the estimated payment requirement and the calculation of the tax. As always, we will follow up with additional guidance as it becomes available.
Please contact Matt Nick, Director, State and Local Tax Services, at Matthew.Nick@CohnReznick.com or 860-271-7933 or Cindy Galamgam, Senior Manager, State and Local Tax Services, at Cynthia.Galamgam@CohnReznick.com or 959-200-7239 to talk about how these changes may impact you.
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