With the enactment of Maryland S.B. 523 earlier this year, Maryland pass-through entities (PTE) can now elect to pay tax at the entity level for resident individual and corporate owners for tax years beginning after December 31, 2019. This would be considered an entity level tax and should be deductible for federal income tax purposes by the PTE based on IRS Notice 2020-75 regarding proposed regulations and not be limited by the $10,000 state and local tax (SALT) deduction limitation at the individual level.
For 2020 the tax rates would be 8.25% for corporate owners and 8% for resident individual owners (highest marginal individual rate of 5.75% + lowest county rate of 2.25%) on the owner’s distributive share of taxable net income. Owners would still be required to file and report the PTE income on their own Maryland tax return but would take a credit for the taxes paid at the entity level. The PTE would subtract the entity level taxes paid in calculating their federal taxable income therefore reducing taxable income distributed to the owner effectively allowing those taxes as a deduction without being subject to the $10,000 SALT limitation at the individual level. Any overpayment of taxes paid by the PTE would be refunded on the individual’s Maryland return. If the owner lives in a county with a higher county rate, they may still need to make estimated tax payments at the individual level.
This new law does not change the withholding requirement for nonresident PTE owners. Those taxes are still considered to be imposed on the nonresident owner and paid on their behalf, so they are not deductible at the entity level in calculating federal taxable net income. If the PTE has resident and nonresident owners, the taxes paid for each will be treated differently.
What does this mean for you? If you have a Maryland PTE and you are a resident of Maryland, you may want to consider having the PTE make this election to save on federal taxes for 2020. If the PTE is a cash basis taxpayer, it may need to pay Maryland estimated tax at the entity level by 12/31/20 in order to take the deduction. Resident owners may be able to reduce their 4th quarter estimated tax payments if the election is being made. For partnerships with both resident and nonresident partners, partnership agreements may need to be amended to specially allocate state tax deductions to resident partners. At this time, we are unsure how this election would work for S Corporations with both resident and nonresident shareholders since we cannot specially allocate income in an S Corporation.
If you have any questions on how this election could benefit your entity, please reach out to your CST Group tax advisor.
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