What is the NC Pass-Through Entity Tax (PTET) Exactly?
In 2018, President Trump passed the Tax Cuts & Jobs Act, which created a $10,000 “cap” on the deduction of state and local taxes for itemizing deductions. Effectively, what this achieved was to take away the federal tax deduction for state income taxes paid.
This new law is a direct response to that action, and many states across the country have enacted similar legislation. This law allows taxpayers who own pass-through entities to pay their state taxes at the entity level, creating a business deduction for the state tax payment. If you elect into this treatment, you will pay all taxes due based on the profit of your pass-through company directly via the business to the NCDOR. This means you may have a large payment to make along with your business tax filing, which is not typically the case.
By directly reducing business income, the state has bypassed the “SALT Cap” by shifting the state income tax expense from your personal itemized deductions to your business’ P&L. The bottom line result is that your taxable income will be reduced by the amount of your state taxes paid for the entity. For every $10,000 in profit from your pass-through entity, you will save approximately $500 in Federal Taxes!
NCDOR Notice and FAQ: https://www.ncdor.gov/important-notice-regarding-north-carolinas-recently-enacted-pass-through-entity-tax-0
The timing of the tax deduction
Your ability to deduct the taxes paid for your pass-through entity is based on cash basis accounting, meaning you get the deduction based on when you make the payment, not necessarily on the period of income being taxed. If you are electing to make the payment for 2022 taxes while filing your taxes in calendar year 2023, you will not get the deduction until filing your 2023 taxes. The benefit will still exist, it will just be deferred.
Note that for tax year 2023, underpayment penalties will apply and you must make quarterly estimated payments for your business just like you normally would for your personal taxes.
How to record the tax payment in your accounting software
You can enter the payment immediately by recording an expense in your software (either “write a check” or add an expense transaction) and ‘matching’ to that item once the check clears, or you can wait for the check to clear your bank and categorize it via your bank feed categorization process.
You will need to create a new expense account called “NC PTE Tax Expense”. You can do this by navigating to your Chart of Accounts, clicking “New”, and adding a new Expense account.
Looking ahead to 2023 – Action Items and advice
· Change your withholding and/or personal estimated taxes to account for PTE payments so that you are not paying the same tax twice throughout the year.
· Set reminders to pay quarterly NC PTE Tax Estimates along with any personal estimated tax payments for Federal tax purposes
· The election is a yearly “opt in”, so if you forgot to make payments you will be able to “opt out” next tax year. You would of course lose the benefit of these payments if you choose to do so.
What if you pay tax in other states?
Many other states with a state income tax have implemented similar laws to the NC PTE tax legislation. If you have a significant tax liability in other states, you should determine if you want to opt in to their version of this law and make entity payments as a non-resident to those states. Any state taxes paid via entity payments are a benefit to you and will save you significantly on Federal taxes.