As a result of the Tax Cuts and Jobs Act, individuals are generally limited to deducting $10,000 of state and local taxes if itemizing deductions. State and local taxes include, individual income taxes, real property taxes, and personal property taxes. Thus, many owners of pass-through entities, such as Partnerships, LLCs, and S Corporations, are unable to deduct some or all of the state and local taxes on the business income from their passthrough entities. Consequently, many states have recently enacted a passthrough entity tax.
The IRS has indicated in Notice 2020-75 that it will issue regulations allowing State taxes paid directly by a Partnership or S-Corp on behalf of its Shareholders to be deducted in computing net income from the partnership. These taxes would be deducted at the entity level and reduce the taxable income received by the partner/shareholder from their K-1. The IRS has indicated that the deduction is allowed even if the sate offers a full or partial credit for the taxes paid by the entity on the partner/shareholder’s individual tax return.
Kansas recently passed a bill retroactively effective 1/1/2022 to allow entities to elect to have Partnership and S-Corp income taxed at the entity level and allowing a refundable credit for the amount of the tax paid by the entity that can be taken on the partner’s/shareholder’s personal return. The Partnership or S-Corp can elect each year when it files the business tax return. If the entity chooses to pay the pass-through entity tax, non-resident shareholders whose only source of Kansas income is from the entity would not be required to file an individual Kansas return.
Missouri also recently passed a similar bill. There are a few key differences between the Kansas law and the Missouri law. Missouri will only allow a credit of 95% of the partner’s/shareholder’s pro-rata share of the tax paid by the entity. The credit will also be non-refundable but can be carried forward to the next year on the partner’s/shareholder’s individual return. As with Kansas, entities operating in Missouri would also elect into this treatment each year when they file their business tax return.
If you have questions, please contact Frank at firstname.lastname@example.org.