Arizona’s Pass Through Entity Tax: What You Need to Know

As a business owner in Arizona, you may have heard about the Pass Through Entity (PTE) tax codified in Arizona Revised Statutes Section 43-1014. This tax can have significant implications for your business and its owners. In this article, we’ll take a deep dive into what the PTE tax is, how it works, and what you need to know to ensure compliance.

What is Arizona’s Pass Through Entity Tax?

The PTE tax was introduced in Arizona in 2019 as part of the state’s efforts to conform to the federal Tax Cuts and Jobs Act (TCJA) of 2017. Essentially, the PTE tax is a workaround for the $10,000 federal cap on state and local tax (SALT) deductions. The tax allows pass-through entities (such as partnerships, S corporations, and LLCs) to pay a tax at the entity level instead of passing through the income to individual owners.

How does the PTE tax work?

Under the PTE tax, pass-through entities taxed as partnerships or S corporations can elect to pay their Arizona income tax at the entity level. The tax is calculated on the Arizona net income attributable to the entity and is based on a sliding scale. For tax year 2022, the tax rate is 2.5%.

The tax paid at the entity level is then credited against the individual business owners’ Arizona income tax liability. The credit is limited to the amount of tax paid at the entity level, and any excess credit cannot be carried forward to future tax years.

What are the benefits of the PTE tax?

One of the primary benefits of the PTE tax is that it allows pass-through entities to avoid the $10,000 cap on SALT deductions at the individual level. By paying the tax at the entity level, the entity can deduct the full amount of the tax paid on its federal tax return. This can result in significant tax savings for owners of pass-through entities.

Additionally, the PTE tax simplifies the tax reporting process for pass-through entities. Instead of having to allocate income and deductions among individual owners, the entity pays the tax on the net income attributable to the entity. This can save time and resources for both the entity and its owners.

What do you need to know to ensure compliance with the PTE tax?

If your pass-through entity elects to pay the PTE tax, there are several things you need to know to ensure compliance with Arizona tax laws. First and foremost, you need to make sure that the election is made on a timely basis. The election for a tax year must be made on or before the due date of the entity’s Arizona income tax return for the year, including extensions.

You also need to make sure that the entity pays the tax on a timely basis. The PTE tax is due on the same date as the entity’s Arizona income tax return, including extensions.

Finally, you need to make sure that the entity provides its owners with the necessary information to claim the credit on their individual income tax returns. This includes the amount of the tax paid at the entity level and the owner’s share of the Arizona net income attributable to the entity.

Ineligible Owners

Member, partners or shareholders that are not individuals, estates or trusts are not eligible for the PTE tax.  Member, partners and shareholders who are individuals, estates or trusts and who opt out of the PTE election are also not eligible for the PTE tax.

Conclusion

Arizona’s Pass Through Entity tax is a new development that can have significant implications for pass-through entities and their owners. By paying the tax at the entity level, owners of pass-through entities can avoid the $10,000 cap on SALT deductions at the individual level and simplify the tax reporting process. However, ensuring compliance with Arizona tax laws is critical to avoid penalties and interest. If you’re a pass-through entity owner in Arizona, it’s essential to consult with a tax professional every year before the end of your entity’s tax year to determine whether the PTE tax is right for your business for the year.  The PTE election may save money some years, but not save money other years.