Friday, January 15, 2021

How to (Try) to Deduct Your Personal Income Tax Liability Against A Business Entity's Taxable Income in Rhode Island

William Delaney, EA
Westwood, MA

Wait a minute…we all know that our personal income tax liability for pass-through income is paid on RI Form 1040, and it isn’t the tax liability of our business (pass-through) entity. They can’t pay our tax without creating taxable income for us due to the payment being classified as a distribution. The corporation or other entity isn’t our personal piggy bank! We all know that---or do we? Shall we continue?


If you attended our splendid state update virtual seminar on Jan. 6 and 7, you heard our speaker from Rhode Island’s Division of Taxation, Leo Lebeuf illustrate and explain the inner workings of making a §44-11-2.3 election. Under this RI General Law enacted in

2019, a pass-through entity (defined under statute as any of the following---S corp.,

general partnership, limited partnership, limited liability partnership, a “member” of an

LLC, a beneficiary of a trust and last, but by no means least, a sole proprietor) may

“elect” to pay the “owner’s” income tax on the entity’s “net income” at a fixed rate of

5.99% .


An owner is defined as an S corporation shareholder;, a partner in one of the specified

types of partnerships; a member of an LLC; a trust beneficiary: or a sole proprietor.


Net income is defined as income reported on Schedule C (sole proprietor) or Schedule

E (other entity types) after removing any Sec. 179 depreciation.


Fine, so what is the point? You write a check out of your sole proprietorship account

(assuming that you have an account specific to your Schedule C activity) or you write

the check out of an account linked to one of the other defined pass-through entities.

How does that become a business deduction on the applicable federal form and the

applicable state form? On this, the statute is silent (do you hear any alarm bells going

off?). Instead, we are referred to IRS Notice 2020-75 (11/10/2020) which the Division of

Taxation apparently believes has somehow given federal approval to the classification

of this type of entity payment as a deductible tax on the federal entity return (yes, that

includes Schedule C). Read on, and let’s see if this interpretation is correct…


The stated purpose of the Notice is to announce that the Treasury and the IRS

“…intend to issue proposed regulations to clarify that State and local income taxes

imposed on and paid by a partnership or an S corporation on its income are

allowed as a deduction by the partnership or S corporation in computing its non-

separately stated taxable income or loss for the taxable year of payment….


The taxable year of payment was interpreted by the RI presenter as meaning the year in

which payment was made; I believe that the correct interpretation of this language

would be the taxable year for which the payment was intended (such as an ES#4, paid

in Jan. 2021, for tax year 2020).


Note also that the purpose statement mentions only two entities, while the RI pass-

through entity also includes a member of an LLC; a beneficiary of a trust; a sole

proprietor. This would cause me to think that the state’s interpretation of the Notice as

covering their expanded definition of a pass-through entity is not correct.


However, does the Notice at least bless the concept that the payments made by either

an S corporation or one of the several partnerships would be interpreted as an income

tax imposed on the entity? It seems to hinge upon a statement in section .02(2) under

Background.


“In enacting section 164(b)(6) [of the Internal Revenue Code], Congress provided that

‘taxes imposed at the entity level, such as a business tax imposed on pass-through

entities, that are reflected in a partner’s or S corporation shareholder’s distributive or

pro-rata share of income or loss on a Schedule K-1 (or similar form) will continue to

reduce such partner’s or shareholder’s distributive or pro-rata share of income as under

present law.’ H.R. Rep No. 115-466, at 260n 172 (2017).


What is §164(b)(6)? It’s the recently enacted SALT limitation. So, if you haven’t

already guessed, it is a back-door approach by RI to get around the SALT limitation.


Will it work…


First, we see how (if it works) the State of RI legislature is thinking. If it is paid by the

entity, and meets the definition of an “entity tax under this subsection” [see §(b)(2) of the

law], that makes it a tax on the “net income” of the entity which is then allowed as a

deduction on the entity’s tax return. If the entity deducts it, that reduces the pass-

through income on the owner’s personal income tax return. So, you can deduct your

personal income tax (if paid by the entity) as an expense against your reportable pass-

through income (the entity adjusts your income downward). You can, according to the

RI legislature, also deduct it directly on your sole proprietorship tax return (so long as it

is not paid from a non-business checking account or credit card, etc.).


After setting forth this interpretation of what is permitted under the federal tax code,

what did RI tell us regarding the state income tax return? First, the payment by the

entity is claimed as a credit against tax liability on the owner’s personal income tax

return. This, effectively, credits the owner as having paid the tax from his/her own

funds. [§(c)(1) of the law]. Second, the entity must reverse the deduction for state tax

paid so that the state version of the owner’s K-1 does not receive the benefit of a state

tax paid deduction. [§(c)(2) of the law]. In other words, the state K-1 is grossed up.


Now let’s return to the federal Notice and read under section 3. Forthcoming

Proposed Regulations. Under .02(1) we find: “…the term ‘Specified Income Tax

Payment’ means any amount paid by a partnership or an S corporation to a State, a

political subdivision of a State…to satisfy its liability for income taxes imposed…on the

partnership or S corporation. Let’s think about this wording…


There must be an income tax liability imposed on the entity. Under the RI statute which

we are reviewing, there is no “income taxes imposed” liability, because the statute

makes no mention of a new tax. In fact, the statute is not even triggered unless an

entity “elects” to make a payment. If the entity does not make the election, the state

doesn’t swoop in and impose the flat rate tax of 5.99%; the state does nothing. You just

file a state tax return without all of the rigmarole. So, is Mr. Lebeuf correct when he

says---why not make the election?


Specified Income Tax Payment (see second preceding paragraph – above) is further

explained/defined…”Thus, this definition solely includes income taxes described in

section 164(b)(2) for which a deduction by a partnership is not disallowed under

§703)a)(2)(B), [state and local taxes], and such income taxes for which a deduction by

an S corporation is not disallowed under §1363(b)(2) [not applicable to our situation].


Now for the punch line…the Notice then goes on to say “…without regard to whether

the imposition of and liability for the income tax is the result of an election by the

entity or whether the partners or shareholders receive a partial or full deduction,

exclusion, credit, or other tax benefit that is based on their share of the amount

paid by the partnership or the S corporation to satisfy its income tax

liability…and which reduces the partners’ or shareholders’ own individual income

tax liabilities…”


So, does it matter if the tax is only self-imposed by election and not uniformly imposed

whether or not you do anything? Apparently it does not, and your Editor now believes

that the position of the RI Division of Taxation is a correct interpretation of the Notice.

Took me a long time to reach this conclusion. One caveat, however. There is no

federal authority for applying the Notice to sole proprietors, trusts, and single member

LLCs which default to disregarded entity tax status. To this extent, I disagree with the

RI Division of Taxation. I don’t see it in the Notice or in the federal tax code.

Thursday, January 7, 2021

Chapter's First Virtual Event A Success!

Thank you to all of our attendees and speakers who made our first virtual event a success over the last 2 days. We had some great discussions led by the Massachusetts Department of Revenue, Rhode Island Division of Taxation, MA/RI Chapter member William Delaney and NY Chapter member and speaker extraordinaire Kathryn Keane.

Instructor Kathryn Keane @ Our Chapter's First Fully Virtual Education Meeting January 2021

MassTaxConnect Upgrade on January 19, 2021

 


MassTaxConnect Upgrade on January 19, 2021
What you need to know
 
MassTaxConnect will shut down on January 15 for the upgrade
The shutdown to complete the upgrade of MassTaxConnect begins next week on Friday, January 15 at 5:00 pm and will end at 6:00 am on January 19. We chose a holiday weekend for the transition to minimize disruption.
 
Plan for estimated tax payments due on January 15
Estimated payments should be submitted before 5:00 pm on January 15. Processing of payments scheduled in advance for withdrawal on the 15th may be delayed but will still be considered to have been made on time.
 
If you intended to make a payment before January 19, DOR will provide some relief. For example, if your estimated tax payment, due January 15, is submitted by January 22, DOR will treat your payment as having been made by January 15. If you are making a bill payment or payment for a return due January 20, any payment made by January 22 will be credited to your account as of January 15.
 
Some things remain the same
The good news is that along with the improvements comes simplicity. There is no need to change your username and password, they remain the same. You will have access to all your information on January 19, including any changes you made to your account right up until the shutdown. All client information will be available after the upgrade.
 
MassTaxConnect video tutorials
The new tutorials are being produced now to reflect the new screens and new processes for MassTaxConnect. They will be available to you when MassTaxConnect is back online at 6:00 am on January 19. Please bookmark the video tutorial page to answer any of your questions about navigating through MassTaxConnect after the upgrade. We think you will find MassTaxConnect very familiar and hope you appreciate the modern design that’s based on user navigation. You’ll also find it easier to access your accounts.
 
Information
Take a look at the sneak preview of the upgrade for a glimpse at the new homepage, account page, improvements to managing access to accounts for those in your group, and a simplified third party view. You will also find more on the upgrade at the information page, including FAQs.
 
More to come
Keep an eye out for a new chatbot feature later in 2021. The chatbot will provide users with instant answers to simple questions, providing a better user experience.

Wednesday, January 6, 2021

MASS/RI Tax Treatment of Certain Federal Cares Act Provisions

William Delaney, EA
Westwood, MA

For personal income taxpayers, Massachusetts has adopted the Internal Revenue Code in effect on January 1, 2005.  For corporation income tax taxpayers, Massachusetts has adopted the Internal Revenue Code as currently in effect.  As you might imagine, this could result in conflict as to how certain recently adopted federal legislation applies to Massachusetts income tax returns.  A few examples…

 

2020 Recovery Rebates to Individuals.  The $1,200/$2,400 rebates are NOT included in MA gross income.

 

Extended/expanded unemployment benefits.  Federal gross income includes unemployment compensation, whether regular, extended or otherwise described.  Likewise, they ARE included in MA gross income.

 

Tax-favored withdrawals from Retirement Plans.  The type of withdrawal which is included in federal gross income ratably over a three-year period, is included in MA gross income at the same time and in the same amount. 

 

PPP Loan Forgiveness.  To the extent that there is loan forgiveness under the CARES Act, the federal “rule” (as clarified under the recently enacted Covid-19 Relief Legislation) is that there is NO loan forgiveness income and any expenses paid from such funds are eligible for the appropriate income tax deduction without restrictions.

 

MA rule for individual taxpayers – the loan forgiveness is included in MA gross income (i.e. it is taxable); the federal deductions are allowed, without restriction.

 

MA rule for corporation taxpayers – the loan forgiveness follows the federal code and is NOT included in MA gross income (i.e. it is not taxable); the federal deductions are allowed, without restriction.

 

Corporation charitable contribution deduction limitation (the 10% rule).  The CARES Act temporarily (for calendar year 2020 only) suspends the 10% of taxable income limitation on the charitable contribution deduction by increasing it to 25%.

MA has adopted the same provision.

 

See MA TIR 20-9 (7/13/20) for more information.

 

Rhode island – conforms to the federal code and has automatically adopted the changes resulting from both the CARES Act and the Covid-19 Act.

Sunday, December 27, 2020

PTIN Renewal Ends December 31

The IRS reminds all active tax preparers to start the upcoming 2021 filing season smoothly by renewing their Preparer Tax Identification Numbers now. All current PTINs will expire December 31, 2020.

Anyone who prepares or helps prepare a federal tax return for compensation must have a valid PTIN from the IRS. They need to include the PTIN on any return filed with the IRS.

Tax preparers must pay a fee of $35.95 to renew or get a PTIN for 2021. This fee is non-refundable.

Those with a 2020 PTIN should use the online renewal process. This takes about 15 minutes. Form W-12, along with the instructions, provide a paper option for PTIN applications and renewals. The paper form can take four to six weeks to process. Failure to have and use a valid PTIN may result in penalties.

How to renew a PTIN online:

  • Go to the TaxProfessionals page on IRS.gov
  • Select the Renew or Register
  • Enter the user ID and password to login to the online PTIN account.
  • Follow the prompts to verify information and answer a few questions

Users will receive confirmation of their PTIN renewal once this process is completed.

Tax preparers can also use the online system to view a summary of the number of tax returns filed using their PTIN and receive secure messages from the IRS Return Preparer Office.

First time PTIN applicants can also apply for a PTIN online.

How to apply for a PTIN online:

  • Go to the TaxProfessionals page on IRS.gov.
  • Select the Renew or Register button and select Create Account in the New User box.
  • First time users are issued a temporary password and will be prompted to change their password when they log in.
  • Select the appropriate PTIN Sign Up option.
  • Follow the prompts.