Pass-Through Tax Savings: What the PTE Deduction is and how it can benefit you.

Since the passing of the Tax Cuts and Jobs Act in 2017 (TCJA), several states have enacted a Pass-Through Entity Deduction (PTE). As of this publication, 34 states and New York City all have versions of the PTE with an additional five proposals in state legislatures. Now the world is asking, “What is the PTE Deduction and why has it become so popular?”?

In order to understand how the PTE can benefit individual taxpayers, we have to look at what taxpayers can deduct on their Federal Tax Returns, and how TCJA reshaped what and how much can be deducted. Prior to TCJA, there were six major categories of expenses that could be deducted from your Federal Tax Return:?

• Medical Expenses?
• State and Local Taxes (SALT)?
• Mortgage Interest?
• Charity?
• Theft & Casualty Losses?
• Unreimbursed Employee Expenses?

This allowed taxpayers in higher tax states like California and New York to deduct their state income taxes on their Federal Tax Returns, and get some relief on their Federal Taxes. However, President Trump argued that allowing the SALT deduction both subsidized higher tax states’ budgets and unfairly penalized them with lower SALT rates. As a result, TCJA enacted a $10,000 cap on the SALT deduction to eliminate this perceived disparity.?

Following the imposition of the $10,000 cap, legislative bodies in high-tax states swiftly sought ways to circumvent this limitation. In 2018, Connecticut introduced a 'Pass-Through Entity Tax'. The PTET was a 6.99% tax on pass-through (Partnership / S-Corp) income that was assessed to the partnership and returned as a credit to the individual partners/shareholders. Since there is no limit on entities’ ability to deduct SALT taxes on their tax returns, Connecticut collects the same amount of state taxes and still provides its taxpayers with the pre-TCJA benefit of deducting their SALT taxes for federal tax purposes. Although the deductions occur at the entity level instead of the personal level, the ultimate benefit to the taxpayer still remains unchanged.?

Each state administers its PTE Deduction differently and taxpayers should consult their tax advisors before attempting to take advantage of any tax strategies, because the underlying principle remains consistent across the 34 states and New York City. Taxpayers pay state tax on the pass-through entity, which subsequently reduces the entity's federal taxable income. The taxpayer will accordingly receive a state tax credit for the payment on their individual tax return.?

Unless the SALT cap is extended, this limitation is scheduled to expire alongside other provisions of the TCJA in 2025. As a result, there are only a limited number of tax years remaining to leverage this strategy and achieve substantial tax savings. If you have a profitable passthrough entity, you should certainly speak with your CPA about implementing the PTE Deduction.?

Doni Dror is a Tax and Accounting Manager of Santa Monica, Calif-based Gerber Kawasaki Inc., an SEC-registered investment firm with approximately $2.2billion in assets under management as of01/03/22. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which course of action may be appropriate for you, consult your financial advisor. No strategy assures success or protects against loss. Readers shouldn't buy any investments without doing their research to determine if the investments are suitable for their situation. "All investments involve risk and one should consult a financial advisor before making any investments. Past performance is not indicative of future results. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice.?