Nebraska Pass-Through Entity Tax (PTET) Analysis

By Jacob H. Owens, CPA - Law Clerk, Smith Pauley LLP

This month ushered in the last calendar quarter of 2023 and, with it, tax planning season for many Nebraskans. However, in completing planning and compliance efforts this tax season, Nebraskan taxpayers will encounter a state tax code that has been altered significantly by Governor Pillen’s 2023 “Historic Tax Cuts Package.” According to Governor Pillen, this legislative tax initiative is intended to “bring transformational tax reform for Nebraskans and provide billions in property, business, and income tax relief for Nebraska businesses, farmers, ranchers, and taxpayers.”

One of the earmark features of Governor Pillen’s “Historic Tax Cuts Package” is the Nebraska Pass-Through Entity Tax, or “PTET” for short. Nebraska’s PTET allows pass-through entities (i.e., partnerships and S-corporations) to elect to pay state income tax at the entity level, rather than the interest holder level.

While the PTET’s concept may be abstract and non-intuitive, the general idea is simple. Typically, when a taxpayer earns income through a pass-through entity that income “passes through” to the taxpayer’s individual income tax return where he or she then pays the appropriate tax. Under this framework, the pass-through entity does not pay any state income tax. Nebraska’s PTET alters this framework by allowing the pass-through entity to pay state income tax at the entity level, rather than the interest holder level.

Easy enough, but what is the point? Why might a taxpayer prefer to pay state income tax at the pass-through entity level? Well, by paying state income tax at the entity level, the taxpayer may be able to effectively deduct the entire amount of his or her state tax payments on his or her federal income tax return and, in doing so, significantly decrease his or her federal income tax liability or significantly increase his or her federal income tax refund. A taxpayer may obtain this federal tax benefit while incurring an identical or only marginally higher state tax liability.

Maintain a comparable state tax liability while simultaneously reducing my federal tax liability or increasing my federal tax refund? That seems too good to be true. Well, actually – no: Nebraska’s PTET serves as a “state-sanctioned tax loophole” of sorts. As part of the Tax Cuts and Jobs Act (“TCJA”) of 2017, the U.S. Congress introduced the “state and local tax deduction limitation,” which is commonly referred to as the “SALT Cap.” Under the SALT Cap, taxpayers are only allowed to deduct up to $10,000 in state and local tax payments from their federal taxable income, meaning that if a taxpayer pays more than $10,000 in state and local taxes, the amount paid in excess of $10,000 is nondeductible and cannot be carried forward or backwards to other tax years. The SALT Cap, however, does not apply to business entities, including pass-through entities. Nebraska’s PTET then gives taxpayers an opportunity to circumvent the SALT Cap by allowing the taxpayers to pay state income tax at the entity level (where the SALT Cap does not apply), rather than the interest holder level (where the SALT Cap does apply). Therefore, Nebraska’s PTET may be beneficial because it allows taxpayers to take a federal income tax deduction for a state and local tax payment that it would otherwise not be allowed to take.

Key Takeaways:

However, the benefit provided by Nebraska’s PTET is not unlimited. First, taxpayers can only take advantage of a PTET election if they take itemized deductions on their federal income tax returns. Further, only taxpayers who pay over $10,000 in cumulative state and local taxes (e.g., income tax, property tax, sales and use tax, etc.) will benefit from making a PTET election. Still, for those taxpayers who are in a position to take advantage of this election, the PTET may provide significant tax benefits. As is mentioned above, the PTET may reduce an electing taxpayer’s federal income tax liability or increase his or her federal income tax refund. The PTET may also retrieve tax benefits from previous years as electing taxpayers may retroactively file a PTET election for any tax year between 2018-2023 (and on). Practically, this means that taxpayers may make the election, amend their returns, and recover significant amounts of money from the federal government.

As always, the discussion above is purely informational. Each taxpayer’s situation is unique and should be considered individually by a qualified tax professional but be sure to look out for Nebraska’s PTET this tax season! Please do not hesitate to contact us if you have any questions or concerns regarding Nebraska’s PTET.

Jacob is a Certified Public Accountant and law clerk based out of Omaha, Nebraska. He is in his final year of law school at the Nebraska College of Law. Here, he is actively engaged in legal scholarship with a strong emphasis on tax policy.  Prior to law school, Jacob spent two years in public accounting assisting clients with tax planning and compliance efforts. He looks forward to using his accounting and legal background to pursue a career solving complex tax issues.