On February 22, 2023, Governor Holcomb signed Senate Bill 2 (SB 2), allowing elective pass-through entity taxation (PTET) for partnerships, S corporations, and LLCs taxed as S corporations or partnerships. The Indiana PTET and accompanying deductible expense election allow the pass-through of reduced federal taxable income to small Indiana business owners, thereby allowing qualifying owners to avoid the Federal $10,000 SALT deduction limit on their individual returns. Indiana law reflects a nationwide trend of state income tax responses to the $10,000 state and local tax (SALT) deduction limit on individual federal tax returns implemented in the Federal Tax Cuts and Jobs Act of 2017
(TCJA). Indiana PTET law corresponds to the IRS’s invitation after the TCJA for state-level legislation in Notice 2020-75. With the changes introduced in SB 2, the State of Indiana is among thirty-five states that allow PTET relief. Pertinent details include:

PTET retroactivity for tax year 2022:

  • PTET elections for tax year 2022 must be made after March 31, 2023, and before August 31, 2024.
  • Tax year 2022 returns filed on or before April 18, 2023, may be amended to elect PTET. For original 2022 returns filed after that date, the PTET election must be on an original return.
  • PTET Election:
    • For tax years after 2022, PTET elections must be made annually by the earlier of:
      • (i) the PTE’s tax return due date, or
      • (ii) the date the PTE files its return.
    •  PTET election is irrevocable for a particular tax year.
  • Qualifying Entities:
    • Pass-through entities that qualify to make the PTE election include partnerships, S
      corporations, and LLCs taxed as an S corporation or partnership.
    • The election is not available to disregarded single-member LLCs and qualified subchapter S subsidiaries.
    • Qualifying Owners:
      • A “Qualifying Owner” includes direct or indirect PTE owners, including entity
        owners, or a beneficiary of an estate or trust. Financial institutions do not qualify as owners.
      • Must include all qualifying PTE owners.
  • PTE Tax:
    • The PTET rate is Indiana’s individual income tax rate on the last day of the PTE’s tax year (3.23% tax rate for 2022).
    • Nonresident owner tax calculated after PTET allocation and apportionment.
    • Resident owner tax calculated either before or after PTET allocation and apportionment – but the electing entity must use the same method for all resident direct owners.
    • For taxable years ending after June 30, 2023, a single estimated payment must be made on or before the end of the tax year.
  • State Tax Credit:
    • Qualifying owners receive a PTE tax credit against their Indiana income tax liability. The credit accounts for the PTE’s tax payment for each owner’s share of taxable income even if entity election not made – up to the amount of PTET paid.
    • PTE taxes paid to other states included in the Indiana tax credit if the other state
    • PTE tax is “substantially similar” to Indiana’s PTE tax.
    • Entity-level income tax withholding requirements reduced by amount of PTET
      credited to owners.

Bottom Line: Indiana’s PTET provides a new opportunity for closely-held business tax planning. As the state and local income tax landscape continues to evolve, Taft’s State and Local Tax Practice is ready to assist.

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