Month: September 2023

We have some critical updates on the pass-through entity tax (PTET), which has recently become the rule in most states rather than the exception.

The PTET enables owners of pass-through businesses, such as S corporations and multi-member LLCs, to navigate around the $10,000 annual limit on state and local taxes (SALT).

How PTET Works

The PTET process is relatively straightforward. A pass-through entity (PTE) can choose to pay state income tax on its business income, which would otherwise pass on to its owners.

The PTE then claims a federal business expense deduction for these state income tax payments. Next, the states allow the owners to claim a credit or a deduction for these taxes, which avoids the SALT limit.

Consequently, owners benefit from the federal deduction against their state income tax and avoid the $10,000 SALT limit on some or all of their pass-through income.

State Updates

Currently, 36 of the 41 states imposing income taxes have adopted some form of PTET. So far, in 2023, Hawaii, Indiana, Iowa, Kentucky, Montana, Nebraska, and West Virginia have enacted a PTET.

Of these, Indiana, Iowa, Kentucky, and West Virginia have made their PTET retroactive to 2022, while Nebraska’s new PTET is retroactive to 2018. Hawaii’s and Montana’s PTETs are not retroactive.

Eligibility

In all states with a PTET, partnerships, S corporations, and multi-member LLCs taxed as partnerships or S corporations are eligible to elect to pay a state PTET. Sole proprietorships, single-member LLCs taxed as sole proprietorships, C corporations, trusts in most states, and LLCs taxed as C corporations are not eligible.

Deadline for PTET Election

No state (except Connecticut) requires a PTE to pay a state PTET; the PTE must elect to do so. The due dates for making the PTET election vary from state to state.

PTET Opt-Outs

In most states, a PTET election is binding on all the PTE’s owners, and individual owners cannot opt out. The only exceptions are Arizona, California, New York, and Utah.

Please call me directly at 408-778-9651 if you have questions about the PTET.

• By Leon Clinton
• September 10, 2023

If you are thinking about offering your employees the new individual coverage health reimbursement arrangement (ICHRA), take a moment to read the insights below.

Class size rule. You face the class size rule only if you offer a traditional group health plan to one class of employees and an ICHRA to another.

Minimum class size example. You cover four full-time employees with group health coverage and offer an ICHRA of $400 a month to your 12 part-time employees. Eight of the part-time employees accept. You satisfy the “same terms” rule and meet the class size requirement.

No minimum class size example. You face no minimum class size requirements when you don’t offer a traditional group health plan. Say you have seven employees. You can offer a $16,000 ICHRA to your two salaried employees and a $5,000 ICHRA to your five hourly employees.

Carryover rules. You can establish your ICHRA so employees can carry over unused amounts to next year.

Section 125 Plan strategy. You can use a cafeteria plan (a Section 125 plan) to let those employees who purchase individual health insurance coverage outside of a public exchange pay the uncovered part of the premium, which allows you and your employees to save on taxes.

Avoiding the $100-a-day-per-employee penalty. The ICHRA avoids the Affordable Care Act’s $100-a-day-per-employee penalty for reimbursing individually purchased health insurance.

Not subject to affordability rules. Businesses with fewer than 50 employees are not subject to affordability rules under Section 4980H, providing additional flexibility.

Qualifying insurance. Insurance that qualifies for the ICHRA includes individual coverage purchased through an exchange or on the open market, and Medicare.

The ICHRA has advantages for the small business. If you want to discuss the ICHRA, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• September 9, 2023

The distinction between repair expenses and improvement costs can impact your tax benefits.

The tax law categorizes repair and improvement costs differently. Repair expenses are generally more beneficial for tax purposes, providing greater after-tax cash value than the depreciation deductions you would get from improvements or additions.

One key reason for this is recapture taxes. When you depreciate a building and then sell it at a profit, a percentage (up to 25 percent) of the straight-line depreciation you claimed on the building is taxed as “unrecaptured Section 1250 gain.” This effectively transforms what you might have considered deductions into something resembling a profit-sharing loan from the IRS, which is repayable upon sale.

Further, depreciation deductions come in small parts over long durations—27.5 years for residential rental properties and 39 years for commercial properties. In comparison, repair expenses can provide immediate tax benefits, depending on how the passive loss rules affect you.

Example. If you spent $30,000 on repairs to your business building and are in the 28 percent tax bracket, you could save $8,400. On the other hand, if you classified the same $30,000 as a capital expenditure (improvement), you would deduct depreciation and save approximately $215 a year.

And this $215 per year is not really $215 a year because it does not consider

• the time value of money, or
• the devastating effect of recapture taxes.

If you would like my help distinguishing between repairs and improvements, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• September 8, 2023