Earlier this year, the state of Minnesota enacted a new Pass‐Through Entity Tax election for S corporations and partnerships. The Pass‐Through Entity Tax is effective for tax years beginning in 2021. Is electing the PTE a good choice for you? We answer your questions.
What is the Pass‐Through Entity Tax? The Pass‐Through Entity Tax is an election available to qualifying entities taxed as S corporations or partnership. The election allows the pass‐through entity to pay state income taxes on its Minnesota taxable income.
What is a “Qualifying Entity”? A Qualifying Entity is defined as an entity taxed as a S corporation or partnership that does not have a corporation, partnership, or LLC as an owner.
How is the election made? The election must be made by owners who collectively own more than 50% of the pass‐through entity and is binding on all owners. The election must be made by the extended due date of the tax return and is irrevocable for that year. It is only binding for that tax year and must be made again in subsequent years.
How is the Pass‐Through Entity Tax calculated? The Pass‐Through Entity Tax is calculated by multiplying MN source taxable income (i.e. apportioned income) at the top MN individual income tax bracket (9.85%).
Tax income $200,000
MN apportionment 90.00%
MN tax income $180,000
Entity Tax $ 17,730
Why elect to pay the Pass‐Through Entity Tax? Currently, individuals can only deduct up to $10,000 of state taxes on their federal individual income tax return. However, businesses do not have a $10,000 limit on their deduction for state income taxes. Paying the Pass‐Through Entity Tax would give individuals who own pass‐through entities the benefit (i.e. lower federal K‐1 income) of deducting the state income taxes on their K‐1 income. Also, individual owners receive a credit on their MN individual tax return for their pro‐rata share of the entity level tax, so they will not be taxed twice by MN.
How will the Pass‐Through Entity Tax be reported for non‐residents? If the Pass‐Through Entity Tax is elected, then there is no requirement for the entity to pay non‐resident withholding or composite tax.
Are entities required to make estimated tax payments of the Pass‐Through Entity Tax? Yes. The rules are the same as other taxes paid by pass‐through entities (composite taxes, minimum fee, etc.). If the taxes will be more than $500, Minnesota estimated tax payments are required.
If you have a business that operates in more than one state, many states have also enacted entity tax options for pass‐throughs. However, each state has its own guidelines and limits.
The MN Pass‐Through Entity Tax is only available while the $10,000 federal deduction cap exists. The federal deduction cap is scheduled to expire after 2025 but there are current proposals in Congress to eliminate or raise the deduction cap.