Income earned by limited liability companies (LLCs), partnerships and S Corporations traditionally passes through to members, partners and shareholders (collectively “partners”). That is why limited liability companies (LLCs), partnerships and S Corporations are commonly referred to as pass-through entities. Partners pay tax on their distributive share of income from the business and typically make estimated payments for that liability.
On May 31, 2018, Connecticut changed the way it taxes pass-through entities. Public Act 18-49 initiates a pass-through entity tax on LLCs taxed as a partnerships, general and limited partnerships, and S corporations (“PTEs”). The legislation does not impact publicly-traded partnerships, sole proprietorships or single-member LLCs that are disregarded entities. Connecticut taxes Connecticut source income of PTEs at the rate of 6.99%.
PTEs must make estimated tax payments to cover their pass-through entity tax. Because the law passed in the middle of the year, PTEs must make “catch-up” estimated tax payments. The law requires estimated payments equal to 22.5% of the pass-through entity tax each quarter. Thus, a PTE is seriously behind on its estimated tax obligations if it has not started making payments to the state. Because individual partners will get a credit for the pass-through entity tax paid by their PTE, many resident individuals will no longer need to make estimated income tax payments to cover Connecticut income from their PTE. If a nonresident individual does not have any other income from Connecticut sources and the PTE pays the pass-through entity tax, then the nonresident individual will no longer have to file a Connecticut income tax return or make estimated tax payments to Connecticut. Most PTEs with corporate partners will elect the alternate method of calculating the new tax, which means the corporation will pay the pass-through entity tax on its distributive share of income from the PTE.
The impetus behind this new entity level tax arises from the new federal income tax law (PL 115-97). The new federal income tax law caps the state and local tax deduction (“the SALT deduction”) for individuals at $10,000. No such limit applies to state and local taxes deducted by business entities. Consequently, the PTE can take a deduction on its federal income tax return for the pass-through entity tax paid to Connecticut. Public Act 18-49 allows partners in a PTE a deduction of 93.01% of the partner’s share of the pass-through entity tax paid by the PTE. In that way, it neutralizes the effect of the new pass-through entity tax and assures that the Connecticut income tax will be deductible on the business federal income tax returns.
If you hold your business or vacation home in an LLC, partnership or S corporation and have not heard of this new law, you must calculate the projected income of your PTE for 2018 and pay 7% of it as estimated taxes. Do not hesitate to contact the estate planning attorneys at Cipparone & Zaccaro, PC if you need any help understanding this new Connecticut tax.
