As I reported in an article earlier this year, the 2021 Idaho Legislature passed a “work-around” for the $10,000 federal limit on an individual’s deduction of state and local taxes.* The new Idaho law, effective January 1, 2021, allows pass-through entities to elect to pay the Idaho income tax that otherwise would have been payable by the owners of the business on the income after it is passed through to the owner. The new term for a partnership, LLC and Sub S corporation eligible to make such an election is “Affected Business Entity” (ABE). Payment by the ABE will be deductible by the entity for federal tax purposes, thus reducing the income allocated to the individual owners. The owners will receive a credit for their share of the ABE’s payment. For instance, if an ABE entity pays $10,000 in tax to Idaho, a 25% owner of the partnership, LLC, or Sub S corporation can claim a credit of $2,500 on his/her Idaho tax return.
The effect of the election is to give a full deduction for the state income taxes attributable to the business. The owner will be able to include other taxes in using the $10,000 limit (such as property taxes, or state income taxes on other income, such as non-business income). Or, if the owner uses the standard deduction, he/she will still have the benefit of the deduction of the state income taxes on the business, because the ABE will have paid it and his/her taxable income will be lower by that amount. Regular corporations have always been able to deduct state income taxes, so this new elective procedure will put individual owners of ABEs on the same footing.
Many tax professionals are now working with their clients to evaluate how this law affects their clients’ tax returns, especially for this current year. The election to be taxed at the entity level does not need to be made until the 2021 entity tax return is filed, or April 15, 2022.** If the payment is made with the return, then the credit will be available to the member/partner for payment on the individual 2021 tax return. However, for cash-basis taxpayers, a 2022 payment will provide a federal tax deduction only on the 2022 tax return.
Accordingly, the immediate tax planning question is whether the entity should make an estimated payment in 2021, with the expectation that an election will be made with the return that is filed. Tax professionals have been working closely with the Tax Commission over the last several weeks to resolve questions about how this election and the associated payments will be made and how they will be treated. Here is what we know now with respect to some important questions:
• It is entirely proper for ABE to make the payment in 2021 even if the entity and its owners do not yet know whether it is advisable to make the election. If the ABE decides not to make the election when it files its 2021 return in 2022, the payment will be refunded, just like any other excess estimated payment.
• It is also proper for the ABE to make the payment in 2021 based on estimated income at the entity level. Any shortfall can be paid with the return, and any excess amount will be refunded.
• The payment can be made with Form 41-ES or using the Quick Pay tool on the Tax Commission’s website. The election is made using a new form, Form-ABE.
• The credit can be passed through different tiers in a multi-tier pass-through organizational structure, down to the individual owner.
There are some cautions to be aware of in deciding whether to make the election and some unknowns that may be resolved in technical changes to the statute this next session (hopefully early in the session):
• For ABEs with non-resident members: those members will get their share of the credit for taxes paid by the entity, which will offset their Idaho income tax. However, most non-residents are subject to tax on all their income in their home state, with a credit given to taxes paid in another state. It is not clear whether other states will give credits for taxes paid by the Idaho ABE, not the individual member who receives only a credit. Idaho’s law has a provision stating that it will honor similar credits given by other states for Idaho residents earning income from such entities in other states and receiving the credit. It may be important to know whether the relevant states for your non-residents have such provisions. If not, it may not make sense to make the election.
• For entities with trusts and estates as members, it is unclear whether the credit can be used by those members. Legislation is being drafted that would make that clear, but we cannot be certain it will be enacted.
• Non-profit entities (such as tax-exempt charities and retirement plans) typically do not need the deduction or the credit, but the statute does not have a process for reducing the entity’s income or transferring the credit to account for that situation.
• A pass-through entity cannot carry back losses, and there is likely no benefit from making the election if the entity is in a loss posture.
It should be emphasized, with respect to these cautions and unknowns, that the pass-through entity can make the estimated tax payment in 2021 to keep the option open to make the election, and will have until the filing date to decide whether to make the election.
If any reader has questions about the issues addressed in this article, you are encouraged to contact your tax professional or Rick Smith of this firm.
**The current law provides that the entity’s payment must be made by April 15. There will likely be a technical correction bill this next session that changes this deadline to the 15th of the fourth month following the end of the tax year.
This client alert has been prepared by Hawley Troxell Ennis & Hawley, LLP for informational purposes only and is not legal advice, a legal opinion, or counsel. Readers receiving information through this client alert should not act on or rely on it without consulting professional legal counsel. Any such opinions, advice, or counsel are dependent upon the application of the law to the particular facts and circumstances of any given situation and should be given by a licensed attorney in the exercise of his or her professional judgment only after the establishment of an attorney-client relationship and based upon the exercise of the attorney’s professional judgment after consideration of such facts and circumstances. The furnishing of this client alert does not constitute or give rise to an attorney-client relationship.