Connecticut Pass-Through Entity Tax

As of January 1, 2018, Connecticut (CT) imposes a new entity level tax at the rate of 6.99% on affected pass-through entities (PE), including partnerships.

There are two methods for calculating this new tax, the Standard Base and the Alternative Base.

The Standard Base

Under this method, the tax is imposed on the PE’s Standard Base which is equal to its CT-sourced income, less any CT source income from subsidiaries that already paid the tax. Although the default method, the Standard Base does not take into account the classification of the PE’s underlying partners/members. As a result, the tax is imposed on the entire Standard Base, with no adjustments for tax exempt partners or non-US partners.

In situations where there are multi-tiered PE structures, if an upper tier PE pays its entity tax due, a lower-tier PE that is a partner in the upper-tier need not pay tax on its share of that CT income (i.e., the lower-tier PE will only owe tax on its other CT income that has gone untaxed). As an example, assume Partnership A has $500 of CT-sourced income, $200 of which was received from Partnership B in which it is a partner. Partnership B filed and paid its entity tax due. Therefore, Partnership A is only subject to entity tax on the remaining $300, leaving a tax liability of $20.97 ($300 x 6.99%).

The Alternative Base

In contrast to the first method, the Alternative Base method allows for adjustments based on the underlying partner composition. Under this method, the tax is imposed on the sum of the PE’s modified CT source income plus the resident portion of its unsourced income. Modified CT source income is the Standard Base multiplied by the percent of the PE’s income directly/indirectly allocated to partners subject to Chapter 229 income tax. Therefore, any partner not subject to CT income tax (typically based on whether an individual or entity is exempt from federal income tax) would not be included in this percentage, which effectively lowers the amount of CT-sourced income.

Further, the resident portion of unsourced income is calculated as unsourced income multiplied by the percent of PE’s income directly allocable to CT resident individual partners. Therefore, any non-individual (e.g. not a natural person), even a CT resident, would be excluded from this percentage causing the resident portion of unsourced income to be lower.

The CT Department of Revenue Services (DRS) has provided the following example: Partnership P is composed of a resident individual, a non-resident individual, a corporation subject to corporate business tax, a tax-exempt entity and a non-US individual. The partners receive distributive shares of 20% each. For 2018, Partnership P has $100,000 of total income, with $60,000 sourced to CT, $20,000 sourced to Massachusetts, and $20,000 unsourced. The following are the tax results:

  • Resident Portion of Unsourced = $20,000 x 20% = $4,000
  • Modified CT Source Income = $60,000 x 60% = $36,000
  • Alternative Base = $36,000 + $4,000 = $40,000
  • Tax Due = $40,000 x 6.99% = $2,796

Using the tiered-structure treatment under the Alternative Base, it is possible to look through the structure to determine the percentage of income directly/indirectly sourced to partners subject to Chapter 229 income tax. Doing so may allow for a decrease in the PE’s modified CT source income that will be subject to tax.

As further provided by the CT DRS: Partnership A has a Standard Base of $20,000. Partnership A is owned by Partnerships B and C which are both owned by a mix of C corporations, insurance companies, and tax-exempt entities. Because the C corporations, insurance companies, and tax-exempt entities are not subject to income tax under Chapter 229, Partnership A’s modified CT source income is $0 and therefore no entity tax will be due. Utilizing the Alternative Base method may allow the passthrough to significantly decrease or altogether avoid paying entity tax on its entire CT-sourced amount. Since income allocated to exempt partners would not be included in the Alternative Base, no tax would be due on their income nor should any tax be allocated to these partners. To ensure the Alternative Base method is used, an election must be made on or before the due date (or extended date) of the return.

Beginning in tax year 2018, estimated payments against the tax due are required to be made quarterly by the PE itself. For calendar year filers, estimated payments, which can be made via a coupon and check to the CT DRS (and electronically starting in September), are due according to the following schedule:


 

Acknowledging late enactment of this new law, the CT DRS allows for catch-up payments to be made to bring PEs into compliance with the payments due. These payments can be made in several ways, including making one lump-sum payment that brings the PE up to date, or annualizing estimated payments for the year. The PE may also re-characterize any estimated payments made by its partners (with partner consent) so that such payments can apply towards its tax liability for the year.

The Takeaway

Going forward, many CT residents will no longer have to make estimated payments on their CT pass-through income, while non-residents, with no other CT income, will generally have no CT income tax filing requirement or estimated payment obligation so long as the PE pays its entity tax due. By contrast, if the PE makes the Alternative Base election, corporate partners should continue to make their estimated payments as done previously. To avoid double taxation, partners may claim a credit on their CT tax returns for their share of the tax paid. It is important that CT residents and non-CT residents with CT source income keep these new rules in mind.