Tax Alert: Indiana Pass-Through Entity Tax Signed Into Law

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Indiana Senate Bill 2 (SB2) was signed into law February 22, 2023. Upon its passage, Indiana joins the increasingly large list of states that have enacted pass-through entity (PTE) tax legislation. 

The PTE tax election will have a retroactive effective date of January 1, 2022 and allows for S corporations, partnerships, or LLCs treated as S corps or partnerships for federal income tax purposes to pay Indiana income taxes at the entity level as the 2023 Indiana General Assembly expedited the passage of Senate Bill 2 (SB2), Gov. Holcomb signed the bill into law. SB2 creates an optional state-level pass-through entity tax (PTET) with a retroactive effective date of Jan. 1, 2022.

The Indiana PTET law is written to provide a federal tax benefit for individual taxpayers while being revenue-neutral for the state of Indiana. The creation of a PTET effectively eliminates the $10,000 cap on an individual’s state tax deduction put into place in 2018 by the Tax Cuts and Jobs Act. The IRS is aware of the now 30 states creating these laws and has blessed the deduction of such taxes at the federal level through the guidance issued in IRS Notice 2020-75.

Indiana’s new PTET law is significant for Indiana taxpayers for a number of reasons, including the following:

• The law allows for Indiana resident pass-through entity owners to elect that ALL of their income be subjected to Indiana tax at the entity level. The Indiana resident individual is entitled to a credit for the PTET paid on their behalf that can be claimed on their individual Indiana return. The $10,000 state tax expense limitation on the federal return does not apply to state taxes expensed by the pass-through entity.
• The definition of credit for taxes paid is expanded beyond other states’ withholding tax or composite tax to also include PTET paid to other states. This opens the door for Indiana resident pass-through entity owners to make PTET elections in other states. For example, a PTET election in California and Minnesota would generate federal benefit equal to 9.3% or 9.85% of taxable income, respectively. The Indiana resident pass-through entity owner can now receive the federal benefit from electing PTET in the other states while also continuing to receive a credit for taxes paid for other states’ PTET.
• This law change puts Indiana on a level playing field with the other 29 states that have already enacted a PTET, several of which neighbor Indiana. Not having a PTET was previously a detractor for individuals or companies looking to relocate.

While it is expected that the election will be beneficial for most Indiana taxpayers, a separate analysis should be done to confirm the benefit. The following is a non-exhaustive list of items that should be considered when analyzing the benefits of PTET elections.

• Do the pass-through entity owners have federal taxable income?
• Where do the owners of the PTET live, and do all the resident states have a PTET?
• Do the states where a PTET election is being considered allow for a credit for taxes paid for other PTET, withholding tax, or composite tax paid on behalf of the owners?
• What federal return tax year will the PTET be deductible, and does that create a timing issue with respect to cash payments and the timing of the federal tax benefit?
• What are the due dates of the state PTET elections?

This new law is nuanced, and its widespread implications are still developing. Turpen & Deckard LLC is in discussion both with the Indiana Department of Revenue and software providers to address immediate concerns regarding filing deadlines and timing of elections, neither of which are clear at this time.

TDLLC will continue to monitor any guidance and provide updates accordingly.