Minnesota’s elective pass-through entity tax was enacted in July and provides a powerful tool to help address the Federal $10,000 cap on state and local tax deductions. This workaround is made possible by electing to have the entity pay its income tax directly, which effectively reduces income passed to each owner in the amount of the state income taxes.
Overview
For tax years 2021 and after, a partnership, limited liability company, or S corporation with only individual, trust, and estate owners may elect to pay a new pass-through entity tax if:
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- The $10,000 state and local tax deduction cap is effective for federal purposes for the tax year,
- Owners collectively holding more than a 50% ownership interest in the entity elect to do so, and
- The entity makes an irrevocable election by the due date or extended due date of its return.
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The election is binding on all qualifying owners who have an ownership interest in the entity.
Application of tax – Outline
The tax imposed equals the sum of the tax liability of each owner, calculated by applying the highest individual tax rate. In addition:
- Nonbusiness deductions, standard deductions, and personal exemptions are not allowed
- Credits and deductions are allowed only to the extent allowed to the individual owner.
The same credits and deductions used to determine an owner’s tax liability for the pass-through entity tax must also be used to calculate the owner’s income tax liability.
Estimated Payments and Credit for Taxes Paid
Pass-through entity tax returns will generally be treated like composite returns for administrative purposes. Estimated tax requirements apply in the same manner as for composite filers. Owners of entities electing to pay the pass-through entity tax can claim a refundable credit for their share of the amount of tax paid by the entity.
Treatment of individual estimates already made prior to the election is not clear at this time, so taxpayers considering this election should be on the lookout for additional guidance.