NYS Pass-Through Entity Tax and Considerations for Construction Firms
By Stephen Cerruto, CPA, Senior Manager, Tax & Business Services
The New York State Pass-through Entity Tax (NY PTET) was newly enacted for the 2021 tax year. It is an optional, entity-level tax that partnerships, multi-member LLCs, and S-corporations can elect.
If elected, the NY PTET subjects the entity to New York State income tax at the entity level, instead of at the level of the individual shareholders. The tax paid under the NY PTET is deductible for federal tax purposes and would be a credit against individual shareholders’ state taxable income.
For an in-depth discussion on this tax and its potential benefits, refer to this previously published article from our state and local tax (SALT) specialists.
SPECIAL CONSIDERATIONS FOR CONTRACTORS
At face value, the NY PTET seems like a great tax savings technique for contractors with operations in New York. However, there are some things construction firms should consider:
New York State Modifications to Income
The NY PTET is based on New York taxable income, which includes income tax modifications specific to New York State. One of the more consequential modifications to consider is the adjustment for bonus depreciation. Bonus depreciation is a method of deducting the entire cost of certain fixed assets the year the item is placed in service. Although the deduction is allowed for federal purposes, New York does not recognize this tax treatment and requires normal tax depreciation methods to be used. As a result, this modification can dramatically affect the calculation of the NY PTET and its benefit to the company owner. This modification is common in the construction industry due to the constant investment of capital in equipment and operations.
For example, consider a fictitious New York company Contractors Inc. Assume the following facts in year one:
- Federal taxable income before depreciation: $725,000.
- New equipment purchased that is eligible for bonus depreciation: $1,000,000.
- First year depreciation using an allowable accelerated method of depreciation: $400,000.
|Income Before Depreciation||$725,000||Income Before Depreciation||$725,000|
|Bonus Depreciation||($1,000,000)||Allowable Depreciation||($400,000)|
|Net Taxable Income / (Loss)||($275,000)||Net Taxable Income / (Loss)||$325,000|
A NY PTET election in this year would benefit Contractors Inc. even though federally, it has a taxable loss.
Using the same facts listed above, assume the following in year two for Contractors Inc.:
- Federal taxable income before depreciation: $200,000.
- No new equipment or fixed asset purchases.
- Second year depreciation using an allowable accelerated method of depreciation for the equipment purchased in year one: $240,000.
|Income Before Depreciation||$200,000||Income Before Depreciation||$200,000|
|Bonus Depreciation||($0)||Allowable Depreciation||($240,000)|
|Net Taxable Income / (Loss)||$200,000||Net Taxable Income / (Loss)||($40,000)|
For Contractors Inc., a NY PTET election would generate no benefit even though federally it has $200,000 of taxable income.
Coordination with Multiple Entities
NY PTET income and the resulting tax due is calculated at the company level. It does not include things such as losses from other entities, individual net operating losses, or entity loss carryovers suspended at the shareholder’s or owner’s individual level. All of these have the potential to greatly reduce how much income is ultimately recognized and taxed at the individual level. A taxpayer who doesn’t take this into account could end up paying significant funds into New York State and tying up much-needed working capital, with no real benefit.
- For example, assume fictional company Construction Co is projecting a 2022 New York tax profit of $1,000,000 from operations in New York State. Let’s also assume that in 2021, Construction Co suffered a loss of $750,000 that was suspended at the shareholder level for basis purposes. Assuming no other factors, the $1,000,000 profit will allow the release of the $750,000 loss. In 2022 the taxable income to the shareholder will be $250,000, resulting in NY taxes of approximately $17,125. If Construction Co had elected NY PTET for 2022, it would have been required to pay in $68,500 in PTET taxes to New York State. This would ultimately trickle down to the shareholder, resulting in an overpayment in excess of $50,000. Although the $50,000 would eventually be refunded, this is a substantial amount of money to have needlessly tied up with New York State when it could have been available for working capital, debt maintenance, payroll, and many other operating expenses.
Financial Statement Income versus Tax Income
When planning for the income taxable under NY PTET, it’s important to remember that it’s based on your tax method of accounting and taxable income, which is usually not the same as your book method of accounting and financial statement income. Significant tax-saving strategies, elections, and deferrals can greatly reduce the income recognized for tax purposes. Be sure to consider the following:
- Deferrals for contracts that are less than 10% complete
- Section 460 allocations.
- Home construction/residential construction deferrals.
- Cash and accrual methods of accounting, as opposed to percentage of completion methods.
All of these can have a significant impact on the taxable income recognized in a given year. The Tax Cuts and Jobs Act significantly expanded the palette of methods available to contractors. If you haven’t reviewed your options recently, it would be beneficial to do so.
The NY PTET isn’t as straightforward a benefit as one may assume, especially for contractors operating under a much more complicated set of tax rules and a more complex financial landscape. Careful thought must be put into whether the NY PTET is truly the right move.
For additional information regarding how the PTET rules may affect you, please contact your Marcum State and Local Tax professional.