by Vidor A. Nosce
Iowa has enacted an entity-level tax election for pass-through entities that allows a partner or shareholder to claim a credit against the individual and franchise taxes paid. (L. 2023, H352, effective 05/11/2023 and made retroactive to 01/01/2023.)
PTE election SALT workaround.
The fiscal notes state that the law is a state and local tax (SALT) limit workaround of the SALT cap imposed by the 2017 Tax Cut and Jobs Act. The law allows certain individual income taxpayers (owners of partnerships and S corporations who make a voluntary election) to pay an Iowa income tax through their pass-through entities (PTE) like partnerships and S corporation businesses. The state PTE tax is treated as a business expense that lowers the taxable income that flows out of the PTE to the individual tax returns of the owners of the PTE. The law then allows a tax credit to compensate entity owners for the PTE tax paid, and the tax credit is split between the owners of the pass-through entity to be used when filing individual income tax returns. This allows entity owners to deduct SALT at the entity level instead of the personal income tax level and avoids the SALT cap.
Election and tax rate.
Taxpayers have to make a separate election for each tax year. The election is irrevocable once made and is binding on the taxpayer and all partners or shareholders. Electing taxpayers do not have to file a composite return in the same tax year. The election is only available in tax years when the SALT cap limitation in IRC § 164(b)(6) is applicable. Publicly traded partnerships as defined in IRC § 7704 are not allowed to make the election. A taxpayer making an election will be subject to the maximum personal income tax rate under Iowa Code § 422.5A.
Credit.
The credit is equal to the product of the ratio of the partner’s or shareholder’s share of the taxpayer’s taxable income over the taxpayer’s total taxable income multiplied by the state tax liability actually paid by the taxpayer; and the difference between 100% and the highest individual income tax rate in effect for the tax year.
If the taxpayer is itself a partner or shareholder of another taxpayer making an election, the credit is allowed. Any credit in excess of the tax liability is refundable. In lieu of claiming a refund, the partner or shareholder may elect to have the overpayment shown on the partner’s or shareholder’s final completed return credited to the tax liability for the following tax year.
Financial franchise tax credit. If the electing taxpayer is also a financial institution subject to the franchise tax under Iowa Code § 422.63, the tax will be reduced by a franchise tax credit equal to the amount of the franchise tax paid by the taxpayer for the same year.
Nonresidents.
A nonresident individual who is a partner or shareholder of an electing PTE is not required to file an individual income tax return for the tax year if the only Iowa source income of the individual is from a taxpayer making the election, the credit allowed to the partner or shareholder equals or exceeds the tax liability of the partner or shareholder for the tax imposed in the tax year the election is made, and if the taxpayer files and pays the tax due.
Estimated tax.
Taxpayers making the election must make estimated payments of tax if the amount of tax, less credits, can reasonably be expected to be more than $1,000 for the tax year. An electing PTE is not required to make estimated tax payments for a tax year beginning prior to the effective date of the law.
Penalty and interest waiver.
The Department of Revenue may waive penalty and interest for a return filing or tax payment related to an election for a tax year ending prior to the effective date of the law.
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