In response to the 2018 federal limitation on itemized deductions for state and local taxes (SALT), at least 36 states have adopted some form of elective or required pass through entity tax (PTET) as of December 2023. Iowa’s PTET tax is elective and allows the entity to deduct the Iowa tax in the year paid before passing through income to the owners on their K-1 forms. Without the election, owners may only deduct their own Iowa income tax as an itemized deduction. In 2022, less than 10% of Iowa taxpayer’s returns our firm prepared filed itemized deductions on their federal returns, because the standard deduction was higher than the allowable itemized amount.
Executive Summary
Electing the Iowa PTET can reduce the tax burden for Iowa owners of profitable partnerships and S-Corporations because it allows the Iowa taxes on the profits to be deducted from the owners’ pass-through income. The more profit an entity has, the more advantageous electing the PTET becomes. It may not be advantageous for low-income owners or entities. The entity makes the election, not the individual owners. The election may be made each year, and it is irrevocable.
While the owner still reports the pass-through income on their individual tax return, the entity provides a refundable tax credit that may exceed the tax owed on the pass-through income. A tax advantage may be gained by the owner’s pass-through income being reduced by the Iowa PTET the entity paid.
On May 11, 2023, Governor Reynolds signed House File 352 which creates a voluntary election for a partnership or S corporation to be subject to Iowa income tax at the entity level. This is referred to as the Pass-Through Entity Tax (PTET). Iowa has an extensive explanation on the state website.
When the pass-through entity elects and pays the PTET, its owners receive a percentage of the PTET as a refundable tax credit. The election is made each year and is irrevocable. The PTET election is scheduled to expire in the same tax year that the individual limitation on the state and local tax (SALT) deduction expires (currently 1/1/26). If that SALT deduction limitation is extended by Congress in the future, the Iowa PTET election will automatically be extended for the same period.
The eligible entities are only business entities that are taxed as a partnership or S corporation for federal and Iowa income tax purposes and that are required to file a federal and Iowa partnership income tax return or a federal and Iowa S corporation income tax return. This may include an S corporation, general partnership, Limited Liability Company (LLC), Limited Liability Partnership (LLP), or Limited Partnership (LP). A publicly traded partnership, a trust, or a single-member LLC or other entity treated as a disregarded entity for federal and Iowa tax purposes is not eligible to make its own PTET election.
The PTET calculation will be made at the entity level according to the electing entity’s Iowa-source distributive items and without regard to the residency or entity type of any owner. The PTET calculation for tax year 2023 will be made on the IA 1065 or IA 1120S return, and the tax rate will be 6%. This is the top tax rate for Iowa individuals in 2023. That is why the election may not be advantageous for lower-income entities. Each owner receives his share of the credit; but since each owner’s tax situation is different, the various owners will not equally benefit from the tax deduction created by the election.
The owners must still claim the income from the pass-through entity on their individual Iowa tax returns. However, the owners receive a refundable Iowa tax credit from the pass-through entity for their share of the Iowa PTET tax paid less the “tax on the tax” (94% of their share of the tax paid in 2023). They also have their share of pass-through income reduced by the Iowa PTET tax paid by the entity on both their state and federal income tax returns. The reduction in the credit is to prevent double-dipping the Iowa tax deduction. Since the entity may choose to make the election each year, the tax paid is deducted from pass through income in the year paid. The entity must make estimated tax payments for years after 2023 to avoid estimated tax penalties. Those payments are also deducted from pass-through income in the year paid.
Missouri and Nebraska have PTET statutes very similar to Iowa. Missouri’s law doesn’t require estimated tax payments from the entity, and Nebraska’s law doesn’t sunset if the SALT provision is removed. Both of these states distribute 100% of the tax as a credit to the owners, and require the owners to add back the tax to their state income.
Non-resident owners of Iowa pass through entities are not required to file Iowa tax returns if their only Iowa income is from entities who have made the PTET election.
IMPORTANT NOTE: This document should not be construed as tax advice. It is simply information to help you understand this new legislation. Some information is simplified for clarity and many details are omitted.