We now have more clarity on a new law that could benefit many Iowa businesses.
In May, Iowa Gov. Kim Reynolds signed into law the Iowa Pass-Through Entity Tax (IA PTET). Since then, we have been waiting for the Iowa Department of Revenue to issue guidance and to open the online portal needed to file this return. In mid-September, final guidance was issued, and on Sept. 29, the portal went live.
The PTET is a popular strategy states have implemented to bypass the $10,000 limit on the state and local tax (SALT) deduction that is imposed on individuals at the federal level. Many other states have adopted similar PTET legislation. Electing to pay this state tax will save many small business owners federal tax.
How can paying more tax end up saving taxes? Good question.
Let’s review how pass-through entities are generally taxed. Under the traditional taxation method for pass-through entities — partnerships and S corporations — business income is “passed through” to the owners and taxed on the individual owner’s income tax return. On the federal income tax return, the owner can deduct all state taxes paid on all income they received as an itemized deduction.
But remember the federal SALT limitation. The $10,000 includes not just the taxes paid on the business income, but all state and local taxes paid. That includes any personal property taxes and any state withholdings on wages. Individuals can reach the $10,000 cap very quickly.
By electing to have the income of a pass-through entity taxed to the entity, the entity gets the deduction for paying the state tax. This reduces the amount of income that is passed out to the owners and reduces their tax liability, thus bypassing the SALT limitation.
If an entity makes the election, each owner will receive a credit to offset their Iowa tax liability. This credit is based on the owner’s share of the IA PTET the entity paid. This credit is needed to prevent the business income from being double taxed by Iowa, once at the entity level and again at the individual level.
The law allows for entities to make an election retroactively for 2022. Entities have until Jan. 2, 2024, to make the election and pay the PTET for the 2022 tax year.
As with all things related to tax law, there are many nuances here and every situation is different. Consult with your tax advisor to see if electing the PTET is right for you.
Michael Hurd, CPA/PFS, CCIFP, is a principal with Honkamp, P.C. He can be reached at mike.hurd@honkamp.com.
