A business tax that’s not a tax
When is a $600 million state business tax not a tax?
When it’s a workaround for a misguided federal income tax change that punishes Connecticut residents. That’s what we’re looking at with the newly enacted state profits tax on partnerships and type-S corporations.
Yes, it’s a new state tax, technically — adopted unanimously by both chambers of the General Assembly and signed into law by Gov. Dannel P. Malloy on May 31. Unlike just about any other tax, it’s designed to save money on federal taxes for the business owners “lucky” enough to pay it, and it should not cost them any more in state taxes.
But that doesn’t mean launching the levy is smooth and easy, or without confusion. Some people will see just a small benefit and may have an administrative headache to go with it. In theory, the idea is simple. The federal tax reform that President Donald Trump and Republicans in Congress slammed through in December sets a limit of $10,000 on deductions for state and local taxes, known as SALT, in the federal income tax. That leaves an estimated $10.3 billion in lost deductions for Connecticut households, which could cost the state economy $3 billion or so — just what the state can’t afford.
Connecticut, New York and New Jersey are jointly preparing a lawsuit challenging the SALT limit as unconstitutional. Meanwhile, the states have adopted laws — including the pass-through business tax — to blunt the effects.
Under the pass-through tax plan, the business itself, not the owners, pays a state tax of 6.99 percent. The owners receive a credit on the tax paid against their state income taxes. And the portion they over- paid is refunded with a check from the state — not a credit against future taxes, but actual money back.
Calculating all this starts to get complicated if, for example, the owners of a partnership collect different shares of the income. Most also don’t pay the highest tax rate of 6.99 percent, so calculating the refund is a bit of a chore.
For those who aren’t losing out under the federal SALT limit, it’s a new way of operating for low benefit — although at the least it will reduce their federal income taxes by reducing their take-home pay.
“I’m fearful it won’t be worth it,” said Patrick Wellspeak, a principal at Wellspeak Dugas & Kane, LLC in Cheshire, a commercial real estate appraisal firm.
Wellspeak is accustomed to complexity. His firm appraised the UBS building in Stamford, the old General Electric Co. headquarters in Fairfield, the Long Wharf Maritime Center in New Haven and many, many other properties.
But when his accountant called a couple of weeks ago announcing the firm must now send in quarterly estimated payments for the LLC’s income, it came as a shock. Dividing the federal tax payments from one business entity to several partners is part of the issue.
“It’s going to be very complicated, Wellspeak said. “It’s like solving a circular equation.”
The tax applies to thousands of partnerships with at least two members and private companies, some of which have more than 100 owners. As it happens, the state Department of Revenue Services is allowing firms to restate personal quarterly filings to business filings after the deadline, which will help matters. And it’s posting updates and clarifications as you read this.
One problem: The department is fighting to get word out on a retroactive tax — a rarity in itself — at a time when its longtime former commissioner, Kevin B. Sullivan, is gone. Sullivan, a former state Senate president and lieutenant governor, was a force behind the passthrough tax and another workaround, enabling towns to set up charities to fund municipal services, which I wrote about earlier this month.
Sullivan would have been the face explaining the new rules in media interviews and gatherings of tax professionals, but he took a private sector job in May.
Examples of how the tax will work are helpful. If a partnership of three members earns $500,000 in profit, it will now pay $34,950 in the new business tax. Its owners will receive credits of $11,650 each, if they all draw the same income.
Those owners would have paid $8,667 in state income taxes on $166,667 in income, in a simplified version of the example. They will now pay less than that, on income reduced by the $11,650, and they will receive refund checks for the difference from the state.
Now we just have to wait to see whether the IRS allows the change. State officials are optimistic, but you never know what the Trump administration will do.