South Carolina Enacts PTE Tax Election As Workaround To $10k SALT Cap
South Carolina enacted S.B. 627 on May 17, 2021, joining 11 other states that have granted pass-through entities (PTEs) the option to be taxed at the entity level on active trade or business income in an effort to help individual residents workaround the $10,000 federal cap on SALT deductions that was included in the 2017 Tax Cuts and Jobs Act. South Carolina’s new PTE election is effective for tax years beginning after 2020.
Which PTEs Qualify to Make the Election?
Partnerships, S corporations and limited liability companies (LLCs) taxed as a partnership or S corporation are eligible to make the election so long as all of the PTE’s owners are “qualified owners” or are partnerships that are owned directly by qualified owners or through other partnerships. South Carolina defines “qualified owner” to include individuals, estates, trusts and other entity types except for corporations, small business trusts and certain other excepted entities.
Impact on PTEs Making the Election
The election to be taxed at the PTE level is made annually and must be made by the due date to file the PTE’s return, including any extensions (this is more taxpayer-friendly than other states that usually require the election to be made by the original due date for the return).
The electing PTE’s “active trade or business income” will be taxed at a 3% rate after applying South Carolina’s apportionment rules. The PTE election would not apply to income that is not defined as active trade or business income, such as an S corporation’s passive investment income taxable under Section 1362, capital gains, interest, dividends, etc. A PTE’s passive income would still be allocated to South Carolina. Any passive income would not be included in an electing PTE’s South Carolina tax base and, instead, is passed through to the partners or shareholders and reported by them on their individual state income tax returns, subject to regular South Carolina income tax rates, not the reduced rate on active trade or business income.
The new law also removes the withholding requirement on nonresident members for electing PTEs’ active trade or business income.
For tax years beginning after 2021, an electing qualified entity will be required to submit estimated tax payments. If the electing entity fails to pay the amount owed to the South Carolina Department of Revenue (SCDOR) with respect to income as a result of the election, the SCDOR may collect the amount from the electing entity or its direct or indirect owners based upon their proportionate share of the PTE’s income, or both.
Impact on Qualified Owners of PTEs Making the Election
In computing South Carolina taxable income, a qualified owner will exclude active trade or business income from the electing qualified entity, provided that the qualified entity properly filed an income tax return and paid the required taxes on the active trade or business income or loss. To the extent a qualified owner also has active trade or business losses from other PTEs, they may not reduce their tax at a rate higher than 3%.
Finally, South Carolina notes that the basis of both resident and nonresident qualified owners of a PTE making the election will be determined as if the PTE tax election had not been made. The basis of the PTE for each qualified owner will be treated as if the owner had properly taken into account each owner's pro rata share of the qualified PTE's items of income, loss and deduction in the manner required with respect to a PTE for which no such election is in effect.
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