Alabama Electing Pass-Through Entity Tax Act
In a previous Beyond the Bottom Line, BMSS briefly highlighted certain Alabama legislation passed earlier this year and signed into law by Governor Ivey. One provision that passed deserves additional attention at this time: the Alabama Electing Pass-Through Entity Tax Act (the “Act”).
With the passage of this Act, Alabama joins other states by enacting its own version of an elective pass-through entity (“PTE”) tax, which allows eligible PTEs (i.e., Subchapter S corporations and Subchapter K entities) to elect to be taxed at the entity level. Electing PTEs are taxed at the highest Alabama marginal individual income tax rate calculated in accordance with the Subchapter K or Subchapter S rules, as appropriate, and apportioned in accordance with the state’s multistate apportionment rules. The electing PTE owners do not receive an Alabama tax credit for their distributive or pro rata share of the income tax paid by the PTE. Rather, the members are not liable for Alabama income tax that would otherwise be imposed on their distributive share of PTE income. The election is effective for tax years beginning on and after January 1, 2021.
The Alabama PTE tax election may be made at any time during the tax year; or, on or before the 15th day of the third month after the close of the tax year for which the election shall be effective. The election is binding until revoked. Both the election and revocation must be made by the PTE’s governing body and by greater than 50% of the voting control of the entity.
The Act, and others like it around the country, are a response to the $10,000 cap placed on the state and local tax deduction that may be taken by individuals under the Tax Cuts and Jobs Act. IRS Notice 2020-75, released on November 9, 2020, provided guidance from the IRS stating that PTEs may claim entity-level deductions for state income tax paid under state laws that shift the tax burden from individual owners to the business entity. The guidance clarifies uncertainty on the issue and supports partnerships and S corporations deducting tax payments that otherwise may be subject to the $10,000 limitation on state and local tax (SALT) if the liability was imposed on individual partners or shareholders.
As mentioned above, the election can be made for PTE tax years beginning on or after January 1, 2021. The election can be made during the year or by the 15th day of the third month after the close of the year (the original due date for PTE income tax filings). If the election is made, estimated tax payments may be required. The Act provides that an Electing Pass-Through Entity shall be subject to the provisions of Section 40-18-80.1 Code of Alabama 1975, (estimated tax for corporations).
If you are a PTE or PTE owner, we want you to be aware of the Act and its opportunity to successfully avoid the $10,000 SALT cap. Tax professionals and PTEs alike, however, need further guidance from the Alabama Department of Revenue (ADOR) on the mechanics and forms required to be completed by PTEs to make the election and to pay estimated tax payments, as well as the timing of those payments. An estimate may be due by April 15, 2021 for a PTE electing this entity tax. BMSS has made inquiries to the ADOR on these matters and will keep you informed of any new developments.