Maryland Comptroller letter to practitioners: Pass-through entity tax return processing

On Sept. 19, 2023, the Maryland Comptroller (Comptroller) issued a letter to tax practitioners (Letter) acknowledging a major deficiency in the agency’s process in accurately processing the income tax returns of pass-through entity (PTE) owners claiming refundable tax credits (refundable credits or credits) paid on their behalf by underlying PTEs doing business in Maryland.

A PTE is a Subchapter S corporation, partnership, or limited liability company that is treated as a partnership for federal income tax purposes. PTEs are not directly subject to income tax at the entity level for federal or Maryland income tax purposes but rather their owners are subject to tax based on their pro-rata share of PTE taxable income. One exception for Maryland income tax purposes is the ability for a PTE to make a pass-through entity tax (PTET) election to pay tax on behalf of all resident (domiciled) and nonresident (nondomiciled) owners by the filing of Form 511, Electing Pass-Through Entity Income Tax Return. In the case of nonresident individual owners included in a PTET election and filing, their share of Maryland PTE income tax liability is paid on their behalf in lieu of any required nonresident withholding or the filing of a composite income tax return on their behalf. 

All owners are allocated Refundable Credits for their pro-rata share of Maryland PTET filed and paid on their behalf to be applied against their state-sourced PTE taxable income claimed on their respective Maryland income tax returns. 

For the last eighteen months, there have been widespread errors and delays in the processing of Maryland PTE owners’ state individual income tax returns claiming their share of PTET refundable credits as an offset against their respective state tax liabilities resulting in either:

1. Long delays in the receipt of refunds for excess Credits exceeding their calculated tax liability
2. The issuance of erroneous underpayment assessment notices reflecting tax due attributable to the owner’s share of refundable credit paid on their behalf not being applied against their tax liability

The Letter acknowledged that these problems have been attributable to staff shortages and outdated technology to where over 176,000 PTET returns for the 2021 tax year are being, or have been, processed with needed validation of the refundable credits claimed in comparison to estimated payments made coupled with the individual PTE owner claiming the proper amount of such credit. In the letter, the Comptroller concedes that an agency’s lack of automation and large value of these credits has resulted in the need to conduct manual validations of credits claimed.

The Letter provides the following actions and long-term solutions that the Comptroller is applying to address this issue including the following:

• A team of revenue agents have been trained to focus solely on validating and resolving PTE returns and to handle practitioner line calls to quickly implement account adjustments.
• Income tax assessment notices for taxpayer underpayments have been temporarily stopped until their validation process yields a higher accuracy rate; however, notices will continue to be generated to notify taxpayers when the refundable credit cannot be granted in the event the PTE has not paid the PTET in full.
• The Letter recommends that tax practitioners filing Maryland PTET returns, as well as the PTE individual owner's state tax returns, apply the eight steps in submitting such filings to help ensure a faster and more accurate process in applying the refundable credits to their owners’ Maryland personal income tax returns.
• In the long term, the Comptroller has commenced a multi-year tax processing replacements project; however, the personal income and PTE components will not be live in the next two years. The agency is also assessing a parallel robotic processing automation tool to eliminate the need for manual handling of the validation process.

Although not addressed in the Letter, nonresident individual taxpayers and their practitioners have also experienced similar widespread errors and delays associated with filing Maryland Form 510, Pass-Through Entity Income Tax Return, and the state nonresident individual income tax returns of their owners.  These errors and delays involve Maryland nonresident withholding not being properly applied on their behalf by PTEs against their state personal income tax liabilities despite the inclusion of all proper documentation with their filings.

What Does CohnReznick Think?

In light of the Maryland Comptroller’s acknowledgment of delays and errors associated with the proper crediting of state nonresident withholding or PTET paid against an individual income taxpayer’s Maryland tax liability, we recommend you consult with your tax advisor in the event that you are impacted upon receipt of an income tax assessment notice or experience a long-term delay in the receipt of your state income tax refund.

Contact

John Iannotti, CPA, Partner, State and Local Tax (SALT)

469.669.7506

Jason Gajramsingh, CPA, Senior Manager, State and Local Tax (SALT)

312.508.5911