As of Jan. 1, 2022, a new piece of Arkansas legislation, The Elective Pass-Through Entity Tax Act (EPTETA), is in effect. The EPTETA aims to provide relief for taxpayers from the $10,000 cap on federal deductions for state and local taxes (SALTs). It was crafted in response to a change made by the 2017 Tax Cuts and Jobs Act (TCJA), which capped the individual deduction for SALT at $10,000 for tax years 2018 through 2025.
A pass-through entity, such as a Partnership or S-Corporation, is called such because it passes its income through to its individual owner, who then pays taxes on that income. While individuals are subject to the $10,000 federal SALT cap, pass-through entities are not. The EPTETA allows a pass-through entity, rather than its owner, to pay the state tax. The benefit of having the company pay the state tax is that the full amount of state tax can then be taken as a business deduction, thereby reducing federal taxable income. This is different than the historical method where the owner would pay the state tax and then be limited to a $10,000 deduction. This new Arkansas legislation reduces the effective tax rate of business owners by up to 2%.
Arkansas is neither the only nor the first state to create a pass-through workaround for the SALT deduction. As of today, 21 other states have passed similar legislation aimed at allowing business owners to avoid losing out as a result of the TCJA SALT cap.
In order to take advantage of the pass-through workaround, Arkansas businesses must opt into the Pass-through Entity Tax by the due date of their business tax return. A business choosing to opt in will be subject to a flat tax rate equal to the highest individual rate, which is currently 5.5%. Capital gains are taxed at half of the ordinary rate.
The Arkansas Department of Finance & Administration is not requiring quarterly estimates for 2022 for businesses that opt into the Passthrough Entity Tax. However, if a business chooses not to opt in, then quarterly estimates will be due from the owners under the normal individual quarterly estimate rules.
There are various complicating factors which must be considered, particularly for businesses operating in multiple states, companies operating at a loss, or Arkansas businesses owned by non-Arkansas residents.
The EPTETA offers an important avenue towards significantly minimizing tax liability. It will be beneficial to many Arkansas taxpayers. Pass-through owners should be sure to consult with an experienced accounting professional in order to determine if the new workaround is beneficial to their situation.