Connecticut Pass-Through Entity Tax

On May 31, 2018, Connecticut governor signed S.B. 11, a bill responding to the federal tax reform legislation passed in December. Included in the bill is a new Connecticut income tax imposed at the entity level on pass-through entities (“PTE”), effective for tax years beginning on or after 1/1/2018.

PTEs subject to the tax include partnerships, limited liability companies (“LLC”) treated as partnerships, and S Corporations.

Calculation of the tax

The legislation imposes the income tax at a rate of 6.99% on the PTE’s taxable income. Taxable income is determined under one of two methods:

1. Connecticut Source Income Method: Under this method, taxable income is equal to the entity’s new income, for federal income tax purposes, that is derived or connected to Connecticut sources, increased or decreased by any adjustment modifications that currently apply to personal income taxes. In determining taxable income, PTEs must also use sourcing rules that apply to personal income taxpayers. If the computation result in a new loss, the net loss may be carried forward to succeeding taxable years until fully used.
2. Alternative Tax Base Method: Entities may elect, each year, to use an alternative tax base in lieu of the Connecticut Source Income Method. An affected business entity making such election must provide written notice to the Commissioner of Revenue Services, no later than the due date, or the extended due date of the return. The alternative tax base is equal to the resident portion of unsourced income plus modified Connecticut source income.
   1. “Resident portion of unsourced income” means unsourced income multiplied by a percentage that equals the sum of the ownership interests in the affected business entity owned by members who are Connecticut residents.
      1. “Unsourced Income” is the entity’s net income for federal income tax purposes, increased or decreased by any state modifications that currently apply to the state personal income tax, regardless of the source of such income. The PTE then subtracts taxable income from Connecticut sources, and also subtracts Connecticut modified federal net income from sources in other states that have jurisdiction to tax the income of the affected business entity. The unsourced income is then multiplied by the sum of the ownership interests in the affected business entity owned by members who are Connecticut residents, to arrive at the “Resident portion of unsourced income.”
   2. “Modified Connecticut source income” is the entity’s taxable income from Connecticut sources, multiplied by a percentage equal to the sum of ownership interests in the business that are held by members that are either 1.) subject to Connecticut personal income tax, or are 2.) PTEs subject to the entity tax, to the extent such businesses are directly or indirectly owned by people subject to the Connecticut personal income tax.

For tiered business structures, a lower-tier entity must subtract or add its distributive share of an upper-tiers entity’s income or loss from Connecticut sources.

The legislation provides a tax credit to S corporation shareholders, partners, and LLC members for Connecticut corporation business tax, personal income tax, in addition to income taxes paid to another state or the District of Columbia. The refundable credit is equal to the shareholder/partner/member’s pro rata share of tax paid by the PTE multiplied by 93.01%.

Nonresident individuals are not required to file a personal income tax return if the PTE income is the only source of Connecticut income for the individual or the individual’s spouse, and the PTE has paid the entity tax. Note: Nonresident members must still file a return if the PTE chooses to file on a combined return (discussed below) and the offsetting credit for the PTE’s tax payment does not completely satisfy the nonresident’s Connecticut personal income tax.

For taxable years beginning on or after January 1, 2018, S.B. 11 eliminates composite returns and payments. PTE tax returns and payments replace PTE composite returns. The filing and payment deadline for PTE also changes from April 15 to March 15 each year.

Entities may elect to file a combined return with one or more commonly-owned pass-through businesses that are subject to the PTE tax. “Commonly-owned” means direct or indirect common ownership of more than 80% of a PTE’s voting control. Entities electing to file a combined return must notify the Connecticut Department of Revenue Services in writing by the original or extended due date of the return. The notice must include the written consent of the other commonly-owned PTEs.

PTEs are now required to remit quarterly estimated tax payments for the PTE tax equal to 25% of the required annual payment, due as follows:

• 25%  by April 15 or the 15th day of the 4th month of the tax year;
• 25% by June 15 or the 15th day of the 6th month of the tax year;
• 25% by September 15 or the 15th day of the 9th month of the tax year; and
• 25% by January 15 of the next tax year.

The required annual payment is the lesser of 90% of the PTE tax reported or due for the current year, or; 100% of the tax reported for the previous tax year, if the return for the previous year covered a 12-month period.

For questions about these law changes or other state and local tax matters, please contact us.