Maryland: Pass-Through Businesses Can Elect To Be Taxed At The Entity Level Starting In 2020

August 2020

Summary

 On May 8, 2020, S.B. 523 was enacted into law without the signature of the Maryland governor. The new law creates an election for pass-through entities (PTEs) to pay tax at the entity level, which, in turn, creates a corresponding tax credit for its members. In response to the federal Tax Cuts and Jobs Act enacted in December 2017, Maryland was one of several states searching for ways to help its residents manage the federal $10,000 SALT deduction limitation and amended Internal Revenue Code (IRC) Section 164. This recently enacted bill is one of those responses and was introduced in the beginning of this year.
 
The new law is effective July 1, 2020, and the election for PTEs applies to tax years beginning on or after January 1, 2020.
 

Details

Pass-Through Entity Tax Election

For tax years beginning after December 31, 2019, Maryland now allows qualifying PTEs to elect to be taxed at the entity level with respect to the distributive shares or pro rata shares of income of resident members of the PTE. Qualifying PTEs include S corporations, partnerships, limited liability companies (LLCs) not taxed as corporations in Maryland, and business or statutory trusts not taxed as corporations in Maryland. Qualifying PTEs with resident individual and corporate members are permitted to make the election. The amount of the PTE tax cannot exceed the PTE’s total distributable cash flow for the tax year. The Maryland PTE tax election does not apply to distributive or pro rata shares of income of tax exempt entities under IRC Section 501 or real estate investment trusts (REITs) defined by IRC Section 856. The new legislation also addresses application of the PTE tax election to tiered partnership structures. 
 
Historically, Maryland has imposed an entity-level tax on PTEs with respect to the entity’s nonresident members based upon the sum of each nonresident member’s distributive or pro rata shares of income. This mandatory PTE nonresident tax imposition was characterized as a state tax paid by the PTE “on behalf of” its nonresident members. The new election expands this treatment to Maryland resident members, but characterizes the PTE tax not as a payment “on behalf of” resident members, but as a tax on the PTE.
 

Tax Rates

Qualifying PTEs that make the election compute an aggregate amount of tax based on rates depending on whether the PTE has resident individual and/or corporate members. If the PTE has corporate members, it calculates its PTE tax at the Maryland corporate income tax rate on corporate members’ distributive or pro rata shares of income. For the 2020 tax year, the corporate income tax rate in Maryland is 8.25%. For individual resident members, the electing PTE must pay tax on individuals’ distributive or pro rata shares of income at the highest marginal state income tax rate, plus the lowest county tax rate. For the 2020 tax year, the highest marginal state individual tax rate is 5.75%, and the lowest county individual tax rate is 2.25%, for a total of 8.0%.
 

Credits for Members of Electing PTEs

If the PTE tax election is made, both corporate and individual members will receive a corresponding and refundable Maryland state income tax credit, as well as a Maryland county tax credit, based on their share of the Maryland PTE tax that was paid by the entity. A member must still include their distributive or pro rata share of PTE income in their Maryland individual or corporate income tax base and compute their respective Maryland income tax but may use the pass-through tax credit to offset their Maryland individual or corporate tax liability. If a member’s Maryland tax liability is less than the amount of the credit, then the excess is treated as a tax refund to the member.
 

Credit for Taxes Paid to Other Jurisdictions

S.B. 523 also allows all PTE members that are Maryland residents to take a credit for state income tax paid to other states, including by the PTE. This credit cannot exceed the member’s share of the pro rata tax paid by the PTE.
 

Making the Election, Forms, and Reporting

At this point, the Maryland Comptroller of the Treasury has not issued any administrative guidance on how to make the PTE tax election, forms for making or reporting the effects of the election, including the tax credits, or guidance on how the PTE is to make tax payments.
 
 

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