If your construction company is structured as a partnership, S corporation, or limited liability company (LLC), it likely bypasses federal corporate income tax by passing tax liability to the individual level. However, a growing number of states now offer pass-through entity taxes (PTETs), which allow these businesses to pay taxes at the entity level. This option can potentially lower overall tax bills, but it’s not without complexities. Let’s explore whether a PTET election makes sense for your business.
What is a PTET?
State PTETs emerged in response to the Tax Cuts and Jobs Act (TCJA), which capped the state and local tax (SALT) deduction at $10,000 per year for individuals. This limit disproportionately affects owners of pass-through entities, as their income flows through to their personal tax returns. For construction business owners, especially those with projects in multiple states, exceeding this limit is common.
PTETs allow the business to pay state taxes on behalf of its owners at the entity level, where the SALT cap doesn’t apply. The owners then receive a tax benefit, such as a credit or deduction, at the individual level. While the overall concept is similar across states, the rules vary widely, affecting factors like eligibility, election timing, revocability, and consent requirements from business owners.
Weighing the Pros and Cons
Potential Benefits:
- Tax Savings: PTETs circumvent the SALT cap, enabling larger deductions at the entity level.
- Lower Adjusted Gross Income (AGI): This can unlock additional tax benefits, like rental loss deductions or higher Roth IRA contribution limits.
- Net Investment Income Tax Reduction: Lower AGI may also reduce exposure to this tax.
Potential Drawbacks:
- Federal Qualified Business Income (QBI) Deduction: Electing a PTET may reduce this deduction, which is set to expire after 2025.
- State Tax Rate Discrepancies: If the PTET rate is higher than an owner’s individual rate, you could end up paying more.
- Double Taxation Risks: Nonresident owners may face double taxation if their home states don’t recognize PTET credits.
- Cash Flow Implications: Estimated payments required for PTETs could strain cash flow.
Administrative Burdens:
PTET elections often come with additional compliance requirements, especially for businesses operating in multiple states. Even in single-state situations, navigating the filing obligations and timing of payments adds complexity.
The Timing Factor
The SALT cap is set to expire after 2025, making the long-term benefits of PTETs uncertain. With potential changes on the horizon, it’s essential to weigh the advantages and disadvantages carefully.
Make an Informed Choice
Before making a PTET election, it’s vital to assess your construction company’s specific circumstances, including ownership structure, cash flow, and state tax obligations. We can help you analyze the costs and benefits to determine whether this strategy aligns with your tax goals.
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