On May 4, 2021, Georgia Gov. Brian Kemp signed House Bill 149, announcing that Georgia will allow all pass-through entities to elect to pay state taxes at the entity level rather than passing the tax burden down to the owners of the entity. 

Quite a few states are making this option available in response to the $10,000 deduction limitation on state and local taxes paid enacted by the 2017 Tax Cuts and Jobs Act.

This election allows the entity to pay state taxes on its income at the top Georgia tax rate (currently 5.75%). Paying taxes at the top rate might sound like a problem until you look at Georgia’s tax brackets. The top rate kicks in at $7,001 of taxable income, so most people are not missing much paying at the top rate.

After making the election, the electing entity will pay and be allowed to deduct state taxes in the calculation of its taxable income.

An Example

Assume a Georgia PTE has a federal taxable income of $1,000,000. Without the election, $1M of taxable income flow through to the owners.

If that entity makes the election, it will pay $57,500 in estimated state taxes during the year and reduce its federal and Georgia taxable income by that amount. The entity pays Georgia tax on the taxable income after the deduction for state taxes paid; 5.75% on $942,500 results in $54,941 of state taxes due. The electing entity now flows through only $942,500 of taxable income to its owners.

At the individual level, the non-electing crowd pays taxes on the $1M passed through and could get up to $10,000 of benefit by deducting state taxes paid on the $1M. Higher-income owners most likely pay other state and local taxes that already use up a good bit of the $10K cap. Therefore, the benefit of paying taxes on the pass-through income at the individual level is minimal.

But, let’s assume our example individual gets the full benefit of the $10K itemized deduction and only pays federal taxes on the remaining $990,000 at the top rate of 37% resulting in federal taxes of $366,300. Our taxpayer then pays Georgia taxes on the $990,000 at 5.75% resulting in state taxes of $56,925. Total taxes paid $423,225.

If the election was made, the individual owners now only pay taxes on $942,500 of taxable income that passes through (remember we received a deduction for the $57,500 of Georgia taxes paid by our PTE); 37% federal taxes on $942,500 results in $348,725 of taxes at the federal level. The individual pays no Georgia taxes on the pass-through income because the PTE already paid. Total taxes paid by the entity is $402,919 ($348,725 + $54,194).

In this simplified scenario, the election saved $20,306 in taxes ($423,225 vs $402,919). That is about 5% of tax savings. Not bad! But, of course, real life is much more complicated.

Potential Problems

If you have out-of-state owners, will making the election have a net benefit for them? What about state credits, charitable donations or guaranteed payments?

Paying taxes at the entity level is certainly worth a look, but how it works for you and your partners will be complicated. Work with your tax professionals to determine if there is a net benefit.

How to Do It

The election is available in tax years beginning on or after Jan. 1, 2022. The election is made on the entity’s 2022 form 700 or 600S. The PTE must obtain consent from all owners and document their consent.

The election must be made at the entity level except where the entity is disregarded (single-member LLC or Subchapter S subsidiary). In those cases, the qualified parent may make the election for itself and its disregarded members.

Timing

As stated earlier, this option becomes available in tax years beginning after Jan. 1, 2022. Therefore most PTEs will be making this election on their 2022 tax returns sometime in 2023.

But Georgia’s regulations require an electing PTE to make estimated tax payments on the same due dates and forms as C corporations.

So, entities will probably make the election in 2023 but will need to make estimated payments starting in April 2022.

Now is the time to discuss this opportunity with your tax adviser.

Disclaimer: As always, please do not take this article as tax advice. You need a real, in-person tax adviser who will watch your back 24-7. If you don’t have one, get one and talk to them about this opportunity.

Curt Fowler is president of Fowler & Company and director at Fowler, Holley, Rambo & Stalvey. He is dedicated to helping leaders build great organizations and better lives for themselves and the people they lead.

Curt and the team at FHRS help leaders build great companies through Fractional CFO, strategy, tax and accounting services.

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