ADOR Issues Helpful Estimated Tax Guidance on New Elective PTE Tax
Earlier this year, Alabama became one of 19 or so states to enact a pass-through entity tax as a workaround to the so-called “SALT Cap” enacted as part of the Tax Cuts and Jobs Act of 2017 that limits the deductibility of state and local taxes to $10,000 (MFJ). An updated map of the states, produced by the AICPA, can be viewed here.
The Alabama Electing Pass-Through Entity Tax Act (Act 2021-1) established a new alternate state income tax applicable only to electing partnerships/LLCs treated as pass-through entities and to S corporations (collectively, "PTE's"). For tax years beginning on or after January 1, 2021, a PTE can elect annually to be taxed at the entity level for Alabama income tax purposes at the highest marginal individual income tax rate (currently 5%) calculated in accordance with the Subchapter K or Subchapter S rules, as appropriate, and apportioned in accordance with Alabama’s multistate corporation apportionment rules.
Initially, the PTE owners’ pro rata or distributive shares of income were to be excluded from their Alabama taxable income, but the Legislature quickly amended the law to provide that the PTE’s income still flows through to its owners. In return, the owner, member, partner, or shareholder is entitled to claim a refundable credit in an amount equal to their pro rata or distributive share of the Alabama income tax paid by the electing PTE. The credit mechanism is intended to allow PTE owners to take full advantage of their federal income tax deduction. This way, the PTE tax will work much like the composite return regime, but with a SALT Cap workaround that can provide a tax benefit at the federal level.
Act 2021-423 also authorized the Alabama Department of Revenue (ADOR) to waive interest and penalties resulting from the underpayment or the electing PTE’s failure to pay the estimated tax due on April 15, 2021. Shortly after the PTE tax was enacted, the ADOR provided guidance that if the underpayment is $500 or less, then penalties and interest will not be incurred. If the underpayment is greater than $500 and is due to the retroactive effect of Act 2021-423, then taxpayers will be eligible for penalty and interest waivers as well.
Last week, the ADOR issued what we expect to be the first of a series of proposed rules needed to implement the PTE tax, focused on the mechanical requirements to make the election and paying the tax. According to the proposed rule, to make the election to be subject to the PTE tax, the PTE must file Form PTE-E, Pass-Through Entity Election Form, electronically via the ADOR’s My Alabama Taxes website “on or before the fifteenth day of the third months following the close of the tax year for which the entity elects to be taxed as an Electing Pass-Through Entity.” The election is binding for the tax year in which it’s approved and all subsequent tax years “until a request to revoke the election is [timely] made.” Thus, once the election is properly made, the PTE must affirmatively opt-out to terminate the election. There are certain voting requirements both for making the election and for opting out.
The key to understanding the proposed rule are the defined terms. The proposed rule tracks previous informal guidance by defining the “required annual payment” as the lesser of 100% of the tax shown on the return for the taxable year or 100% of the tax shown on the return for the preceding year. Although the proposed rule does not state, previous guidance provided that if the entity was a PTE during the previous year -- and therefore didn’t owe income tax for that year -- the previous year’s tax safe harbor was calculated as if the PTE was a C corporation.
According to the proposed rule, an entity making the election must file Alabama Form EPT, Electing Pass-Through Entity Payment Return, in addition to a complete Form 20S, S-Corporation Information/Tax Return, or Form 65, Alabama Partnership/Limited Liability Company Return of Income, for the applicable taxable year for which the election was made and all taxable years thereafter unless the election is terminated.
Interestingly, the proposed rule limits the credits that are available to the electing PTE to just the Alabama Historic Rehabilitation Tax Credit and the Railroad Modernization Act Credit. “All other tax credits shall pass through to and may be claimed by an eligible taxpayer under the provisions applicable to that credit.”
The public hearing on this proposal will be held October 5, 2021.