There has been some new significant activity relating to Connecticut’s Pass-Through Entity Tax.
First, the Connecticut Senate and House have adopted and sent to the Governor for signature a 2019 Budget Bill. One of the provisions in the Budget Bill would reduce the amount of the personal income tax credit that is currently available to members, partners, and shareholders for their share of the Pass-Through Entity Tax that is paid by the pass-through entity. The amount of the available credit would drop from 93.01% down to 87.5%, which would have the effect of increasing the personal income tax liability of each pass-through member, partner or shareholder of a pass-through entity that is subject to the Pass-Through Entity Tax. By way of example, assume a pass-through entity had $100,000 of net income in 2019, all of which was Connecticut source income. The pass-through entity would owe a pass-through entity tax to Connecticut of 6.99% of its Connecticut source income, or $6,990. Assuming the tax to Connecticut is paid prior to the end of the 2019 year, the amount of income that would be allocated to the members of the pass-through entity would be $100,000 less the $6,990 pass-through entity tax, or $93,010. Assuming the owners are Connecticut residents in the maximum Connecticut tax bracket, the allocation to them of $93,010 of income would result in a Connecticut tax liability of 6.99% of $93,010, or $6,501. Under existing law, the members would be entitled to a credit against their personal income tax liability of 93.01% of their share of the $6,990 in Pass-through Entity Tax paid by the pass-through entity, or $6,501. This credit would have the effect of eliminating the member’s tax liability from the Connecticut source income that has been allocated to such member, as was the intention of the legislation that was adopted last year. However, under the Budget Bill provision (which, if signed by the Governor, will take effect as of January 1, 2019), the member will only be entitled to take a credit of 87.5% (not 93.01%) of $6,990 of Pass-Through Entity Tax paid by the pass-through entity. This will reduce the amount of the credit available to the member from $6,501 to $6,116. As a result, instead of having the member’s tax liability on the Connecticut source income allocated to the member by the pass-through entity being fully offset by the credit, the member will see an increase in the member’s personal income tax liability by $385 (i.e $6,501 – 6,116). The additional tax amount will increase as the amount of Connecticut source income allocated to the members increases.
In addition, to the Connecticut legislative change, there is an update on the status of the federal review of State legislation, such as the Pass-Through Entity Tax legislation. Since its adoption in early 2018, Connecticut tax practitioners have been waiting for word from the Internal Revenue Service (“IRS”) as to whether the IRS will challenge the federal deduction of the Pass-Through Entity Tax by a pass-through entity on its federal tax return. Connecticut is one of a very few number of states in the country that has adopted a pass-through entity tax as a workaround to the federal limitations on the deduction of state and local taxes that were imposed by the Tax Cuts and Jobs Act. The website for the White House Office of Information and Regulatory Affairs was recently updated to provide that that office concluded its review of IRS proposed regulations dealing with Code Section 164 and 170(c) and State and Local Tax Credits and Charitable Contributions on May 31, 2019, and had returned the proposed regulations back to the Treasury Department. Based on the completion of this review, it would appear that the IRS’s release of these regulations is imminent.