State & Local Tax Update: Connecticut’s Response to Tax Reform
The Connecticut General Assembly recently passed legislation which made changes to the state’s taxing system effective for tax years beginning on or after Jan. 1, 2018. Most significant is the imposition of tax on pass-through entities that are doing business in Connecticut.
Pass-through entities subject to the new entity level tax – otherwise knowns as Affected Business Entities, or ABEs – are defined to include partnerships, LLCs (treated as a partnership for federal tax purposes), and S corporations. The pro-rata percentage of this tax paid by the ABEs is available as a credit on an individual or corporate level Connecticut return, limited to 93.01 percent of the pro-rata taxes paid. Projections and estimates should be evaluated by your tax advisor to determine the impact of these changes to your filings.
A more detailed summary of changes is as follows:
General Tax Provision Changes
- Entity Level Taxation:
- ABEs are now taxed at the entity level
- Tax rate is 6.99 percent
- Combined Return Option:
- Commonly owned ABEs that are subject to tax can elect to file a return on a combined basis. “Commonly owned” means more than 80 percent of voting control of the ABE is directly or indirectly owned by a common owner/owners. The federal rules of constructive ownership under Internal Revenue Code (IRC) 318 apply. (P.A. 18-49, § 1(j)(1))
- ABEs electing to file a combined return will be included in one return that apportions and calculates tax on a post-apportionment ABE basis and will be netted together on the return filing. (P.A. 18-49, § 1(j)(2))
- The election to file a combined return is due on the due date of the return, including any requested extensions. (P.A. 18-49, § 1(j)(1))
- Alternative Tax Calculation Option:
- ABEs can elect to calculate tax on an alternative basis which includes the resident member’s pro rata share of non-Connecticut income by submitting a written request to the commissioner. The Connecticut Department of Revenue Services believes this method will be a likely election for ABEs controlled by corporate partners as it is similar to flowing up income and apportionment factors as was done for tax years beginning prior to Jan. 1, 2018. (P.A. 18-49, § 1(k); State of Connecticut Special Notice 2018(4))
- Due Dates/Estimates:
- ABEs returns are due on or before the 15th day of the third month following the close of each taxable year. (P.A. 18-49, § 1(b))
- ABEs must make estimated tax payments in four installments that add up to 90 percent of the current year tax or 100 percent of the prior year tax to avoid late or underpayment penalties by the original due date of the return. (P.A. 18-49, § 2(a))
- Due to the timing of the passing of Connecticut’s legislation, the first estimated tax installment is late. Connecticut offers three methods to comply with the 2018 estimated payment requirements:
- Make a catch-up payment with the second installment on June 15 that satisfies both the first and second estimated payments requirements;
- Make three estimated payments each equaling 22.5 percent of the liability with the full amount due by the return due date; or,
P.A. 18-49, § 2(b)(1(2); State of Connecticut Special Notice 2018(4))
- Loss Carryforward:
If the calculation of Connecticut taxable income results in a loss for an ABE, then the net loss may be carried forward to succeeding taxable years until fully used. (P.A. 18-49, § 1(c))
- K-1 Information:
The same information required to be included on prior return K-1s must be included in a return filed by an ABE with the addition of the direct pro rata share of tax paid by it and the pro rata share of tax paid by a lower-tier entity. (Conn. Gen. Stat. § 12-726(a))
- The pro-rata percentage of this tax paid by the ABE is available as a credit on an individual or corporate level Connecticut return, limited to 93.01 percent of the pro-rata taxes paid.
Individual Tax Changes
- Individual owners of an ABE whose pro-rata credit for taxes paid by the ABE exceeds the amount of tax due will be refunded the excess. (P.A. 18-49, § 1(g)(1))
- Bonus depreciation taken under 168(k) now to be added back for personal income tax purposes. For personal income tax purposes, 25 percent of the bonus depreciation added back can be deducted in the succeeding four taxable years. (Conn. Gen. Stat. §12-701 (20)(A)(ix); (Conn. Gen. Stat. § 12-701 (20)(B)(v))
- Eighty percent of the federal 179 deduction must be added back in the current year. Twenty-five percent of the amount added back can be deducted in the succeeding four taxable years. (Conn. Gen. Stat. § 12-701(20)(A)(xiv); Conn. Gen. Stat. § 12-701 (B)(xxiv))
- Effective for tax years beginning on or after Jan. 1, 2019, Connecticut will allow for a credit for a tax on wages that is paid to another state or D.C. by an employer on behalf of an employee. Connecticut will only allow the credit if the other jurisdiction considers it an income tax, and comparable credit may be claimed by the resident or part-year resident. This appears to be a law change directed at the recent New York State law change allowing for a voluntary credit to be used to offset New York State tax. (Conn. Gen. Stat. § 12-704(a)(5))
- Resident individual owners of an ABE are entitled to a credit for their pro rata share of tax paid by the entity, subject to the 93.01 percent limitation. (P.A. 18-49, § 1(g)(1))
- Individuals and other pass-through entities which are members of an ABE are entitled to a credit against Connecticut personal income tax for pro-rata tax paid by the ABE to another state or D.C. with a substantially similar entity level tax as Connecticut’s new tax imposed on ABEs. (P.A. 18-49, § 1(g)(1)(B))
- Nonresident individuals are not required to file an income tax return if only Connecticut income is from an ABE that does not file a combined return as long as the amount of nonresident individual member’s credit satisfies the tax due. (P.A. 18-49, § 1(e))
- Nonresident individuals are not required to file an income tax return if their only Connecticut income is from an ABE that does not file a combined return as long as the amount of nonresident individual member’s credit from the ABE satisfies their nonresident Connecticut tax due. (P.A. 18-49, § 1(e) & (g)(1))
Corporate Tax Changes
- Corporate owners of an ABE whose credit for tax paid by the ABE exceeds the amount of tax it is required to pay to Connecticut will be permitted a credit carried forward until used. (P.A. 18-49, § 1(g)(2))
- Connecticut continues to decouple from federal bonus depreciation under IRC 168(k).
- C corporations will continue to decouple using the traditional method; C corporations will not be using the addback and 25 percent deduction method described above for individuals.
- The changes to the treatment of bonus depreciation for an ABE can result in a situation where the bonus depreciation modification is calculated two different ways in quantifying tax for a Connecticut C corp return. (Conn. Gen. Stat. §12-217(b)(1)
- Eighty percent of the federal 179 deduction must be added back in the current year. Twenty-five percent of the amount added back can be deducted in the succeeding four taxable years. (Conn. Gen. Stat. § 12-217(b)(2)(C))
- Deduction for dividends received and disallowance of expenses remain the same. Adds presumption that expenses related to dividends are equal to five percent of the amount of dividends received. Any amount of income due to the disallowance of expenses related to dividends is subject to apportionment. (Conn. Gen. Stat. § 12-217(a)(2)(B))
- Business interest shall be determined as provided in the IRC without applying the provisions of 163(j). (Conn. Gen. Stat. § 12-217(a)(6))
Property Tax Changes
- In only participating municipalities, residential property owners can file an application with the municipality or town to receive a credit against resident property tax due for contributing to a community-supporting organization. The amount of credit that can be allowed is the lesser of: 1) amount of property tax due, or 2) 85 percent of the amount of voluntary, unrestricted, and irrevocable cash donations made to the organization in the calendar year preceding when the application is filed. (P.A. 18-49, § 10)
- Essentially, the individual will be receiving a property tax credit for making a cash donation to an approved community-supporting organization potentially allowing the individual a federal charitable contribution.
Keeping you updated on COVID-19 and its impact on businesses and individuals.