Accounting Considerations for Pass-Through Entity Tax
Understanding the Accounting Implications of Pass-Through Entity Taxation
The Tax Cuts and Jobs Act of 2017 (TCJA) has drastically changed the landscape of U.S. taxes. One of the most significant changes is the SALT cap, which limits the amount of state and local taxes that can be deducted from a taxpayer’s federal tax liability. This has caused many companies to look for ways to effectively bypass the cap and continue to maximize their deductions. One such solution is the pass-through entity tax (PTET) regime, which is gaining traction due to its potential for tax savings.
While the PTET has the potential to be a powerful tax savings tool, it also introduces considerations for businesses preparing U.S. GAAP financial statements.
ASC 740 Accounting Requirements
The accounting requirements are complex by the unique nature of PTE tax regimes, which vary by state and may involve entity-level income tax liabilities imposed on traditionally nontaxable PTEs.
Evaluating the accounting for these tax regimes should begin with establishing if it is within the scope of ASC 740, which means the tax must be paid by the PTE alone and be based on taxable income. This analysis can be complicated because the ASC 740 determination does not rest solely on the direct obligation of tax on the PTE under a state’s tax laws. Unfortunately, the inconsistent nature among various states means the PTET regime of certain states will be within the scope of ASC 740. In contrast, the regime for others will be treated as a transaction with the owners.
Another consideration in accounting for a PTET is the timing of recognition. If a jurisdiction’s PTET is within the scope of ASC 740, then accounting for the effects of the election occurs when the election is filed with the taxing authority. For example, if a business makes an election in a filing with the taxing authority before year-end, it will account for the PTET under ASC 740 during the current period. An election filed with the taxing authority after year-end that is retroactive to the prior year for tax purposes is not reflected in the current year’s financial statements. Instead, this election should be reported as a subsequent event. This treatment would not be affected by a board resolution or other actions the business takes before year-end.
If a jurisdiction’s PTET is accounted for as an equity distribution, the timing of recognition is based on the commitment to its owners. So, if a business has passed a board resolution to participate in a PTET regime before year-end, the entity may have in substance declared distribution and should accrue the allocation as of that date. The subsequent filing of the tax election after year-end does not affect when a distribution is accrued.
There are numerous considerations of a PTET election and every state has different regulations, so a thorough understanding is needed. A CPA can analyze your situation, assist with the tax savings process and help you understand the interplay with ASC 740. Contact an Adams Brown advisor if you have any questions about PTET elections or want to discuss options.