Entity-Level Income Taxes on Pass- Through Businesses

By: Heather Poole, Associate Analyst March 8, 2018 | 2018-R-0090

Issue Do any states impose an entity-level income tax on pass-through businesses similar to the tax proposed in SB 11?

Entity-Level Income Taxes Currently, pass-through entities doing business in Connecticut do not pay taxes at the entity level; instead, their profits “pass through” to their owners and are taxed as part of the owners’ individual tax returns. Pass-through entities include S Corporations, limited liability companies (LLCs), general partnerships, and limited liability partnerships (LLPs).

SB 11 would impose a new income tax on most pass-through businesses at the entity level. (Specifically, the tax would apply to S corporations and businesses treated as partnerships for federal tax purposes.) The tax would be levied at the top personal income tax rate of 6.99% but would be offset by a credit at the personal or corporate income tax level. According to Office of Policy and Management Secretary Ben Barnes, this would provide affected business entities with favorable tax treatment in light of the cap on personal income tax deductions for state and local taxes (i.e., SALT deduction) included in the federal Tax Cuts and Jobs Act.

At least nine states, plus New York City and the District of Columbia, impose an entity-level income tax similar to the one proposed under SB 11 (see Attachment 1 for a description of these taxes). Of these, five states do not levy an individual income tax (Nevada, New Hampshire, Tennessee, Texas, and Washington) and two states (Kentucky and Ohio), the District of Columbia, and New York City www.cga.ct.gov/olr Connecticut General Assembly (860) 240-8400 [email protected] Office of Legislative Research Room 5300 Stephanie A. D’Ambrose, Director Legislative Office Building provide an offsetting personal income tax credit or deduction. Other states impose annual fees or flat taxes on pass-through entities, such as annual filing fees or partnership fees. A recent State Tax Notes article details these taxes and fees.

Attachment 1 Table 1 provides a brief description of each tax and indicates whether or not the state or city allows an offsetting tax credit or deduction against another state tax (e.g., personal or corporate income tax).

Table 1: Entity-Level Income Taxes Tax Description Offsetting Credit or Deduction Alabama Applies to corporations, limited liability entities, and entities considered No Business “disregarded” for federal tax purposes Privilege Tax In general, rate is: (Ala.Code § 40- 14A-22)  $0.25 per $1,000 for taxable incomes less than $1,  $1 per $1,000 for incomes of at least $1 but less than $200,000,  $1.25 per $1,000 for incomes of at least $200,000 but less than $500,000,  $1.50 per $1,000 for incomes of at least $500,000 but less than $2,500,000, and  $1.75 per $1,000 for incomes of $2,500,000 or higher.

In general, the minimum tax is $100 and the maximum is $15,000 District of Generally applies to any trade or business conducted by an individual Business income Columbia or entity, other than a corporation; exempt businesses include taxed at the entity Unincorporated professional firms (1) with gross income which is at least 80% derived level is subtracted Business from personal services rendered by members of the entity and (2) for from income for Franchise Tax which capital is not a material income-producing factor personal income tax (DC ST § 47- purposes 1808.03) Rate is 8.25% of taxable income

Minimum tax is (1) $250 if DC gross receipts are $1 million or less and (2) $1,000 if DC gross receipts are greater than $1 million Illinois Applies to corporations, partnerships, trusts, S corporations, and public No Personal utilities Property Replacement Rate is 1.5% of net income for partnerships and S corporations

Tax No minimum tax (35 ILCS 5/201)

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Table 1 (continued)

Tax Description Offsetting Credit or Deduction Kentucky Applies to corporations and limited liability pass-through entities (e.g., Members are Limited LLCs and LLPs) with gross receipts or gross profits greater than $3 generally allowed a Liability Entity million personal income tax Tax credit or corporate (KRS In general, tax is lesser of (1) $0.095 per $100 of Kentucky gross income tax credit for §141.0401) receipts or (2) $0.75 per $100 of Kentucky gross profits; taxpayers with limited liability entity gross receipts or gross profits between $3 million and $6 million may taxes paid reduce their taxes by a specified formula

Minimum tax is $175 Nevada Generally applies to all business entities with at least $4 million in No individual income Commerce Tax annual gross revenue tax (N.R.S. 363C) Rate varies from 0.051% to 0.331% of gross revenue, depending on industry

No minimum tax New Business Enterprise Tax No broad-based Hampshire Applies to all business entities with more than $208,000 in gross individual income tax Business receipts or an enterprise value tax base greater than $104,000 (state taxes interest Enterprise Tax and dividend income) (N.H. Rev. Stat. Rate is 0.72% of the enterprise value tax base (i.e., the sum of all § 77-E:2); compensation paid or accrued, interest paid or accrued, and dividends Business paid by the enterprise, after adjustments and apportionment); no Profits Tax minimum tax

(N.H. Rev. Stat. Business Profits Tax § 77-A:2); and Applies to all business entities organized for gain or profit with at least Interest and $50,000 in gross receipts Dividend Tax (N.H. Rev. Stat. Rate is 8.5% of taxable business profits; no minimum tax § 77:4) Interest and Dividend Tax Applies to New Hampshire residents, fiduciaries, LLCs, partnerships, and associations with non-transferable shares whose gross interest and dividend income exceeds $2,400

Rate is 5% of interest and dividend income; no minimum tax New York City Generally applies to individuals and unincorporated entities engaged in Individual city Unincorporated any trade, profession, or business; exceptions include performing residents may claim a Business Tax services as an employee credit against their (UBT) New York City (NYC Admin. Rate is 4% of taxable income allocated to New York City; no minimum personal income tax Code 11-501 - tax for a portion of UBT

11-540) Businesses with liabilities less than $5,400 may receive a full or partial tax payments made UBT tax credit

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Table 1 (continued)

Tax Description Offsetting Credit or Deduction Ohio Generally applies to all business entities with gross receipts greater First $250,000 (joint Commercial than $150,000 filers) or $125,000 Activity Tax (single filers) of (Ohio Rev Code Rate equals (1) an annual minimum tax of $150 to $26,000, business income is § 5751.03) depending on gross receipts plus (2) 0.26% of gross receipts in excess deductible for of $1 million personal income tax purposes Tennessee Franchise and Excise Taxes No broad-based Franchise and Applies to any individual or entity doing business in the state individual income tax Excise Taxes (tax on interest and (Tenn. Code Franchise tax rate is $0.25 per $100 of net worth (i.e., the difference dividend income only) Ann. § 67-4- between total assets and total liabilities); minimum tax is $100.

2007); Interest Excise tax rate equals 6.5% of net earnings and Dividends Taxes (Tenn. Interest and Dividend Taxes Code Ann. § Applies to individuals and partnerships whose taxable interest and 67-2-102) dividend income exceeds $1,250

Tax equals 5% of dividend and interest income Texas Generally applies to any business entity formed in or doing business in No individual income Franchise Tax Texas; exceptions include sole proprietors and general partnerships tax (T.C.A., Tax owned entirely by natural persons Code § 171.001) Base is the lesser of (1) 70% of total revenue, (2) total revenue minus the costs of goods sold, (3) total revenue minus total compensation, or (4) total revenue minus $1 million

Tax rate is 0.375% for retailers or wholesalers and 0.75% for other types of businesses; no minimum tax Washington Applies to any individual or entity engaged in business No individual income Business and tax Occupation Tax Rate equals 0.138% to 3.3% of gross receipts, depending on industry (RCWA 82.04.220)

Source: State Tax Notes, “An Update on the State Tax Treatment of LLCs and LLPs,” January 8, 2018; state tax department websites

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