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Indiana Enacts Retroactive Pass-through Entity Tax – Senate Enrolled Act 2

By Laura Rakaska, CPA, Tax Manager and Amy Sandlin, CPA, Tax Senior Manager at Blue & Co.

On February 22nd, Governor Eric Holcomb signed Indiana Senate Enrolled Act 2, making Indiana the 30th state to enact pass-through entity tax (PTET) legislation. This bill received full bipartisan support because it levels the playing field for businesses operating in Indiana and provides tax relief for Indiana residents.

To understand the impact of the legislation, you need a brief history of tax legislation changes.

The Tax Cuts and Jobs Act of 2017 (TCJA) limited the deduction for state and local taxes to $10,000 for individuals who itemize deductions for tax years beginning after December 31, 2017 and before January 1, 2026.

Shortly after the passage of TCJA, states began looking at options (commonly referred to as “SALT cap workarounds”) to reduce the impact of this limitation.

Pass-through entity tax allows state income tax to be paid directly by the pass-through entity, rather than the pass-through level entity owner.

The goal of the PTE tax legislation is to maximize the individual state tax deduction for federal purposes and reduce federal income tax.

PTE tax is only one of the workarounds states have considered after the enactment of TCJA.

However, it is the workaround the IRS has indicated they will allow. After the IRS issued Notice 2020-75, most states with income taxes began enacting pass-through entity legislation that would benefit business owners with operations in their state. With the passage of SEA 2, Indiana joins those states.

For more information on pass-through entity tax, see our article here.

Highlights of the Indiana Senate Enrolled Act 2:

  • It is retroactive to January 1, 2022, which means it is an option for returns that will be filed during 2023.
  • Indiana PTE tax is optional, and pass-through entities opt into PTE tax by making an annual election.
  • The PTE tax election is available to partnerships and S corporations, and eligible PTE owners can include individuals other pass-through entities, C corporations, and beneficiaries of an estate or trust.
  • PTE owners claim a refundable credit on their individual tax returns for the pro rata share of the credit allocated to them by the pass-through entity.
  • Credit for taxes paid to other states under similar PTE taxes can now be claimed on Indiana individual tax return. Additionally, the provision allowing this credit is retroactive to January 1, 2019, so PTE owners with business operations in other states may be eligible for a refund from prior year tax returns.
  • Indiana PTE tax applies only to state income tax, not county income tax.
  • Penalties are waived through August 30, 2024, for any late payments of this tax for tax years ending before January 1, 2023. Since guidance on state PTE and the federal income tax consequences are constantly evolving, this provision may allow taxpayers some flexibility to revise their PTE filing plan without being penalized.

While the PTE tax may result in significant savings for many, each situation is unique and will need to be evaluated independently 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 PTET election
  • Increased compliance costs for PTE tax filers

For PTEs that make this election for 2022, the election will not be available until April 1st, which is after the original due date of the PTE’s federal income tax return (March 15, 2023).

Extensions will be necessary if the pass-through entity wants to elect PTE tax on an originally filed return for 2022.

There are still many unanswered questions on how this legislation will be implemented. Specific guidance is expected to be issued by the Indiana Department of Revenue over the next couple of weeks.

Additionally, software vendors will need to change their current forms and capabilities to comply with the department’s guidance. All of this will impact when PTEs and their owners can file their 2022 returns.

Blue & Co. has been actively involved throughout the passage of this bill and will continue to monitor and react to new information as it becomes available.

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.

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.

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