Tax Reform Closed the Door on Deducting State Tax Payments — and Oklahoma Opened a Window

For the 2019 tax year, pass-through entities doing business in Oklahoma have until June 27, 2019, to choose to pay taxes at the entity level, instead of the member level — a choice that allows state income tax to be fully deductible on federal tax returns. The Oklahoma Tax Commission hasn't yet issued guidance or forms for making the election. When they do, pass-through entities will have to move quickly. 

On April 29, 2019, Oklahoma enacted the “Pass-Through Entity Tax Equity Act of 2019” to mitigate the effects of a new federal cap on state and local tax deductions. Even with a lower marginal federal rate, the $10,000 deduction limit has a negative effect on Oklahoma residents operating as pass-through entities, which led legislators to design this alternative.

Essentially, the Tax Equity Act (House Bill 2665) allows members of pass-through entities — partnerships, limited liability companies and S corporations — to elect to pay tax at the entity level, where state tax is still deductible, instead of at the individual level. The pass-through entity members’ taxable income is reduced by their share of the income that has already been taxed.

This bill is retroactive to January 1, 2019, but entities must file the election by June 27, 2019 (60 days after the legislation was enacted). The Oklahoma Tax Commission has not yet published guidance or forms for filing this election. When the guidance is issued, entities will have to move quickly.

These are some other key points to remember:

  • Taxes paid by electing entities are calculated for each member, then aggregated and paid by the entity. Individuals, trusts, and estates will pay the highest Oklahoma marginal tax rate for individuals; corporations, financial institutions and pass-through entities pay 6%; and exempt organizations pay the same tax they would have paid otherwise.
  • Nonresident entity members will not have to file an Oklahoma return if all of their Oklahoma-taxable income comes from pass-through entities that have made this election and paid the taxes due.
  • Entities making this election will be required to pay estimated taxes, beginning in 2020.
  • The election can be revoked by the entity, and it may be revoked by the state for failure to pay taxes.
  • Losses resulting from this election can be carried back or carried forward for the purposes of calculating Oklahoma income tax.

Would electing to pay income tax at the entity level be beneficial for your members? That depends on many different factors. If this choice applies to you, or you want to learn more, contact Weaver to discuss the pros and cons for your specific situation. 

Authored by George Rendziperis, J.D.

© 2019