By Amy Sandlin, CPA, Tax Senior Manager at Blue & Co.
On March 31st, Governor Andy Beshear signed House Bill 5, which includes a retroactive pass-through entity (PTE) tax effective for tax years beginning on or after January 1, 2022.
If you have been keeping track of Kentucky PTE tax legislation in recent weeks, HB5 may be a surprise. It is the second iteration of PTE tax enacted for Kentucky this year – House Bill 360 was signed into law March 24th.
HB 5 is a substantial overhaul of the PTE tax enacted in HB 360, and HB 5 is undoubtedly more beneficial to Kentucky taxpayers. You can (and should) ignore the PTE tax provisions enacted in HB 360.
For a detailed explanation of passthrough entity taxes – why states have enacted them and how taxpayers may benefit – see our article here.
PTE Taxation in Kentucky: House Bill 5 Highlights
- It is retroactive to January 1, 2022, which means it available for returns filed during 2023. Kentucky PTEs and PTE owners should extend their 2022 returns by April 18th to take advantage of the PTE election.
- Electing PTEs pay Kentucky income tax at the entity level on the passthrough entity’s Kentucky income.
- PTEs with any type of owner can make the PTE election. If the PTE makes the election, all owners are included – resident and nonresident individuals, other pass-through entities, C corporations, and beneficiaries of an estate or trust.
- PTE owners claim a refundable tax credit on their Kentucky income tax returns for the pro rata share of the PTE tax credit allocated to them by the pass-through entity for the PTE tax paid at the entity level. This is the mechanism to prevent double taxation at the entity level and then again at the owner level.
- Kentucky PTE tax is optional, and pass-through entities opt into PTE tax by making an annual election.
- Kentucky residents can now claim a credit for taxes paid to other states for similar PTE tax provisions enacted in other states.
- Penalties and interest provisions provide the necessary relief to allow Kentucky taxpayers to take advantage of the retroactive PTE election for 2022 without being penalized.
- Penalties & interest will not be assessed for late payment of PTE tax for passthroughs that elect PTE for tax years beginning on or after January 1, 2022, but before January 1, 2023.
- Underpayment of estimated tax penalties will not apply to the PTE tax liability for tax years beginning on or after January 1, 2022, but before January 1, 2024.
- The penalty and interest relief does not apply to other Kentucky tax liabilities of the PTE or the PTE owner.
Challenges and Considerations for PTE Elections for the 2022 Tax Year
Kentucky taxpayers may take advantage of tax savings by making the election for their 2022 PTE returns.
However, since this legislation was enacted with less than two weeks left in the 2022 tax filing season, our ability to work through its impact and best advise you for your circumstances is severely limited.
While the PTE tax election may result in significant savings for many, each situation is unique and will need to be evaluated to determine if it’s the right choice for you.
Several factors will need to be considered, including:
- The state residence of all the pass-through entity owners,
- Other states’ treatment of PTE taxes and whether they allow residents to claim PTE tax as a credit for taxes paid to other states,
- The year the PTE can deduct its PTE tax, which determines when the PTE owner realizes the benefit of the PTE election,
- Increased compliance costs for PTE tax filers.
There are still many unanswered questions on how this legislation will be implemented.
The election and tax returns for 2022 will not be available until later this year.
Tax software vendors will need to change their current forms and capabilities to implement this legislation. All of this will impact when PTEs and their owners can file their 2022 returns.
Our Recommendations: What to Do Next?
Your tax advisor will work directly with you to guide you through the impact of this legislation and to provide you all the information you need to determine if this election is right for you.
However, we need implementation guidance from Kentucky Department of Revenue before we can determine the full impact on your personal tax situation.
We do not anticipate being able to accurately analyze the benefits of a PTE election until after the April tax deadline.
Therefore, for taxpayers that may benefit from a PTE election, we recommend extending your passthrough entity and individual tax returns, so you do not lose this opportunity merely because the legislation change occurred during the 2022 tax return filing season.
Don’t be afraid to extend to take advantage of this tax savings opportunity – filing an extension does not increase your risk of audit.
Many of your trusted Blue & Co. advisors are extending their personal tax returns to take advantage of this legislation!
For now, don’t hesitate to reach out to your local Blue & Co. advisor with any other questions or concerns you may have regarding your 2022 taxes.