Governor Signs MSCPA Pass-Through Entity HB1668

     Governor Tate Reeves signed the MSCPA’s pass-through entities technical corrections bill on March 23.  This victory is a culmination of many months of discussions and meetings with Legislators and the MS Department of Revenue (MDOR) by members of our Taxation Committee and Legislation Committee. Special thanks to MSCPA Taxation Committee Chairman Rob Zischke, John Fletcher, Frank , and Tony Huffman for their relentless efforts throughout the process, and to our lobbyist Stephen Clay. The bill passed both the House and Senate unanimously. We are appreciative of key State leaders who were instrumental in drafting and supporting the bill: Speaker Phillip Gunn, Lt. Governor Delbert Hosemann, Representative Trey Lamar and Senator Josh Harkins. 

FINAL BILL SUMMARY:

• Clarifies that an extension extends the election time. Although MDOR had indicated that an extension filed by the entity extends the time to make the election, the original legislation did not reflect this.
• Clarifies that any PTE credits that exceed an owner’s income tax liability are refundable or can be taken as a credit carryforward into subsequent tax periods.  The original legislation did not expressly address this important practical issue, and the feature should also help preserve the benefit of the rate differences between corporate and individual owners of a PTE.  The PTE tax is computed at a flat 5% rate, but in 2022 the state reduced the individual income tax rate by eliminating the 4% tax bracket and enacting scheduled reductions of the top 5% rate to 4% by 2026.  Following that rate reduction, an individual owner’s flow-through credit would be based on the 5% PTE tax rate, calculated at the entity level, but their individual liability would have been calculated at the lower 4% rate.  If the PTE credit is not refundable, an individual owner could effectively lose the benefit of that earlier rate reduction. 

• Removes a potential “double-dipping” scenario.  The original legislation stated that income of a PTE is exempt at the owner level, but also provided that the owners receive a credit equal to the taxes paid at the PTE level.  A strict reading of that could lead to an unintended double benefit, so the proposed legislation would clarify that the owner includes its share of the PTE income in calculating the owner’s gross Mississippi income tax liability, and then claims the credit for the taxes paid at the entity level.  The legislation ensures that no credits are able to be used twice (once at the PTE level and again at the owner level) and that the calculations function to ensure that non-corporate owners receive the benefit of the lower tax rates applicable to individuals.
• Confirms that the PTE credit is calculated prior to application of any PTE-level tax credits.  A concern under the original law was that if it were interpreted that an owner-level credit for tax paid by the PTE is calculated based on the amount of tax paid after the application of PTE-level credits, that might effectively nullify the benefit of the entity-level business credit (such as Ad Valorem or Children’s Promise Credits).  The following example helps to illustrate the issue:
• Assume the PTE has $1,000,000 of taxable income, so its initial entity-level income tax liability would be $50,000 (assuming flat 5% rate for model purposes).  If it generated and claimed a $50,000 ad valorem tax credit, its net entity-level tax liability would be $0.
• Also assume the PTE has two equal owners.  Each owner gets an equal allocation of $500,000 of taxable income but will not receive any credit for tax paid at the PTE level if that credit is based on the PTE’s final tax liability.  When the owners compute their separate owner-level tax liabilities, they have $500,000 of income x 5% rate (assuming the maximum corporate rate) resulting in each having a tax liability of $25,000.  But each owner’s share of the PTE credit for tax paid at the PTE level is $0, so they have a net $25,000 shortfall and effectively lose the benefit of the entity-level tax credit.
• The bill’s solution is to allow the PTE credit to be calculated based on the gross entity-level tax determined prior to the application of any business credits at the PTE level.  In the above example, each owner could claim a PTE credit of $25,000, fully offsetting the liability associated with that PTE income.  The owners also would claim their pro-rata share of the ad valorem tax credit (or any other credits generated at the PTE level), thereby ensuring that they receive the full benefit of the rate differential and the value of those credits.
• Modifies the election process to account for different PTE internal voting requirements.  To make or revoke an election, the original legislation required that there be “a vote by or written consent of the members of the governing body of the entity as well as a vote by or written consent of the owners, members, partners or shareholders holding greater than fifty percent (50%) of the voting control of the entity, within the time prescribed in this subsection.”  Thus, the approval must be made at two levels even though management decisions may or may not be centralized in a board or other governing body, the vote must pass by a specified threshold that may not be consistent with other voting rights/thresholds provided under an entity’s governance documents, and the votes must take place within a specified period.  A strict reading of the statutory election requirement also posed questions whether a simple manager governance structure constitutes a centralized board or “other governing body.”  The legislation accommodates other internal management and voting arrangements.
• Transition language.  The bill provides that the changes shall take effect and be in force from and after January 1, 2023, and shall be applicable to any income tax returns the original due date of which are on or after such date.  That should make the technical revisions applicable to the vast majority of PTE returns that would be filed for the 2022 tax year. 

Co-authored by John Fletcher, Jones Walker