The Connecticut General Assembly approved legislation that would impose an income tax on pass-through entities effective for tax years beginning after 2017.
What pass-throughs pay the tax?
The legislation applies the tax to:
- S corporations;
- partnerships; and
- limited liability companies (LLCs) treated as a partnership for federal income tax purposes.
It does not apply the tax to publicly-traded partnerships that:
- agree to file an annual Connecticut partnership return; and
- report certain information for unitholders with more than $500 in distributive income from Connecticut sources.
A publicly-traded partnership’s information report must include the unitholders:
- address; and
- Social Security or federal employer identification number.
How do pass-throughs compute the tax?
The legislation imposes the income tax at a rate of 6.99% on a pass-through’s:
- taxable income; or
- alternative tax base.
Taxable income includes:
- federal net income under IRC Sec. 702 from Connecticut sources modified by
- Connecticut addition and subtraction adjustments from Connecticut sources.
The addition and subtraction adjustments are those that apply to personal income taxpayers. In determining taxable income, pass-throughs must also use sourcing rules that apply to personal income taxpayers.
Can pass-throughs use net losses?
If the computation results in a net loss, the legislation permits the pass-through to carryforward the loss until it fully uses the loss.
How do tiered pass-throughs compute the tax?
Under the legislation, a lower-tier entity must add or subtract its distributive share of an upper-tier entity’s:
- income from Connecticut sources; or
- loss from Connecticut sources.
How do pass-throughs compute the alternative tax base?
The alternative tax base equals:
- the resident portion of unsourced income; and
- modified Connecticut source income.
What is the resident portion of unsourced income?
The resident portion of unsourced income equals unsourced income multiplied by a percentage equal to the sum of the pass-through ownership interests belonging to Connecticut residents.
What is unsourced income?
Unsourced income equals:
- federal net income computed under IRC Sec. 702, regardless of the source, modified by;
- Connecticut addition and subtraction adjustments, regardless of the source.
The pass-through then subtracts:
- taxable income from Connecticut sources, without any tiered entity adjustments; and
- Connecticut modified federal net income from sources in other states that have jurisdiction to tax that income.
Does the tax offset a pass-through owner’s other tax liability?
The legislation provides a credit to S corporation shareholders, partners, and LLC members for:
- Connecticut corporate business tax payments;
- Connecticut personal income tax payments; and
- income tax payments to another state or the District of Columbia.
The refundable credit for Connecticut tax payments equals:
- the shareholder’s, partner’s, or member’s proportional share of the pass-through entity tax paid multiplied by
Do pass-through reporting requirements change?
Pass-through entity tax returns and payments replace pass-through entity composite returns and payments. The filing and payment deadline for pass-throughs also changes from April 15 to March 15 each year.
Do pass-throughs have any other reporting options?
Under the legislation, pass-throughs may choose to file a combined return with 1 or more commonly-owned pass-throughs subject to the tax. Tax liability applies jointly and separately to each pass-through electing to file a combined return. The election would not affect any other Connecticut tax calculation, except the credits allowed for other tax payments.
What does common ownership mean?
“Commonly-owned” means direct or indirect common ownership of more than 80% of a pass-through’s voting control. IRC Sec. 318 determines whether voting control is indirectly owned.
How do pass-throughs choose combined reporting?
Any pass-through that chooses to file a combined return must notify the Connecticut Department of Revenue Services (DRS) in writing by:
- the original; or.
- extended due date of its return.
The notice must include the written consent of the other commonly-owned pass-throughs.
How do pass-throughs filing a combined return compute the tax?
Pass-throughs filing a combined return must:
- net their taxable incomes after the amounts are separately allocated by each pass-through; or
- net their alternative tax bases.
What must pass-throughs report to their owners?
The legislation requires pass-throughs to annually report each owner’s:
- direct proportional share of the tax imposed on the pass-through; and
- indirect proportional share of the tax imposed on any upper-tier entities of which the pass-through is a member.
Pass-throughs that file a combined report must report to the DRS the direct and indirect proportional share of the tax allocated to each of their members. The report must be filed with the combined return. The allocation is also irrevocable.
Do filing requirements change for pass-through owners?
Under current law, pass-throughs must generally file a composite income tax return and pay the tax for any nonresident owner. The legislation eliminates this requirement for tax years beginning on or after January 1, 2018.
In addition, nonresident individuals are not required to file a personal income tax return if:
- the pass-through income is the only source of Connecticut income for the individual or the individual’s spouse; and
- the pass-through has paid the entity tax.
However, a nonresident individual must still file a return if the nonresident’s:
- pass-through chooses to file a combined return; and
- offsetting credit for the pass-through’s tax payment does not completely satisfy the nonresident’s Connecticut personal income tax liability.
What happens if a pass-through doesn’t pay the tax?
Enforcement and collection actions under existing law apply to any pass-through that doesn’t pay the tax within 30 days of its due date. This includes action to:
- sign a warrant for control of the business;
- place a lien on the pass-through’s property;
- impose penalties and interest.
The legislation also authorizes the attorney general to start civil proceedings to collect the tax.
An interest penalty applies to any pass-through that doesn’t pay the tax. The penalty equals 1% each month, or part of a month, until the pass-through pays the tax.
Do estimated tax requirements change?
Taxpayers must currently pay estimated Connecticut income tax, if expected liability for the tax year is $1,000 or more after subtracting:
- tax credits; and
- Connecticut income tax withheld.
However, pass-through entities are not required to pay any estimated composite income tax payments for nonresident owners.
The legislation requires quarterly estimated payments for the pass-through entity tax 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.
Is there an estimated tax safe harbor?
The required annual payment or safe harbor calculation equals:
- 90% of the tax reported or due for the current tax year; or
- 100% of the tax reported for the previous tax year, if the return for the previous year covered a 12-month period.
Can pass-throughs use the annualized income installment method for estimated tax?
The legislation allows pass-throughs to use the annualized income installment method to compute estimated tax liability if it results in a lower installment payment. The installment equals the applicable percentage multiplied by the tax that would be due if:
- the taxable income for the months in the tax year before the installment’s due date exceeds
- the total amount of any required installments for the tax year.
The applicable percentage equals:
- 22.5% for installment 1;
- 45% for installment 2;
- 67.5% for installment 3; and
- 90% for installment 4.
A pass-through must recapture any installment reduction resulting from this calculation by increasing:
- the next installment; and
- later installments, if the reduction has not been recaptured.
What if pass-throughs underpay estimated tax?
An interest penalty applies to any pass-through that underpays estimated tax. The penalty equals 1% of the underpayment each month, or part of a month, during the underpayment period. The underpayment amount is the amount by which the required installment exceeds the payment made, if any, on or before the installment’s due date.
Interest applies from the installment due date to the earlier of:
- the date on which the pass-through pays the underpayment;
- the 15th day of the 3rd month after the close of pass-through’s tax year.
S.B. 11, as passed by the Connecticut Senate on May 8 and by the House of Representatives on May 9, 2018