On February 22, 2023, Indiana Governor Eric Holcomb signed new legislation into law that allows passthrough entities (partnerships, S-corps, etc.) to elect to pay Indiana income tax at the entity level. This election creates a tax savings opportunity because the state income tax paid at the entity level will be an above-the-line tax deduction for federal tax purposes. Prior to the new election, the deduction for Indiana income taxes paid on passthrough K-1 income was only allowed as an itemized deduction on the individual’s return. Since most individuals either do not itemize or are subject to the $10,000 limit on deductions for state and local taxes, the election will allow for a deduction of state income taxes that were previously not deductible for most individuals. The tax paid at the entity level passes through as a refundable credit to the individual and can be used to offset individual income taxes on the individual’s state income tax return.
An example of the potential tax savings
If a passthrough entity has $50,000 of taxable income and makes the election, the entity will pay $1,615 of entity-level tax. Assuming the individual’s marginal federal tax rate is 24%, the election could create an additional $388 in federal tax savings. The higher the income from the passthrough entity and the higher the marginal federal tax rate of the individual, the greater the potential tax savings.
Retroactive
The new legislation is retroactive to January 1, 2022, and the election can be made for 2022 income tax returns. However, returns with the election cannot be filed before April 1, 2023. Due to the retroactive nature of the change, the delayed filing until at least April 1, 2023, and the time it will take the Department of Revenue, tax software vendors, and tax preparers to implement the new procedures, clients who may benefit from the election should consider filing for an extension.
We are here to help you
We are currently in the process of evaluating the new law’s impact on our clients and the potential tax savings of making the election for 2022 tax returns. If you have any questions about how the new law may impact you, please contact your Whitinger advisor to discuss your specific situation.