How do I add back non resident PTE tax when NOT making the election

[LauraMac1]

When client does NOT make the election to remit PTE tax on all members shares, Maryland still requires the PTE tax to be withheld on non resident shareholders.  It's mandatory.  I don't see any reason why this deduction cannot be taken on the federal return, but I don't see any way to add this back to the Maryland taxable income. None of the "adjustments" section on the state return are actually adding to the MD taxable income unless I "make" the election.  Am I missing something?

If it's only deductible (federally) when MAKING a state election, can anyone direct me to the IRS guidance that supports that conclusion?  

[LauraMac1]

Note - this is for an 1120S 2022 return; and the corresponding 510.  The 511 form is only available if the entity "makes" the election.   However, the non resident taxes still must be paid quarterly and in my mind, should still be able to be a federal deduction added back to the State.  I don't see any way to do this in proconnect.

[sjrcpa]

The nonresident withholding is a distribution. It is not deductible on the 1120S. The whole point of making the PTET election is so it can be deducted on the pass through entity's federal return, bypassing the $10K SALT limit that individuals have.

The shareholder can deduct the amount of the nonresident tax withheld on their share of the 1120S K-1 income on their Schedule A Itemized Deductions to the extent it was paid in 2022. If paid in 2023 they get a 2023 deduction. Their Sch A deductions are subject to the $10K limit.

[LauraMac1]

Thank you - I appreciate your response but I've read the 1120S instructions thoroughly, and I cannot find support for the position in your reply.

The nature of the payment, whether the entity is required to make it, or the entity elects to make it, is the same.  In the first case, it's a mandatory tax and legitimate business expense required to be withheld for non-resident shareholders. In the second case, it's elected. But it doesn't really matter if it's elected, it has to be paid anyway.  Therefore, I don't believe that the federal return basically "cares" what checkbox happens at the state level as to how it's made. Just that it's been made.

Does anyone have any specific IRS guidance that refutes this? Or is this an imposition improperly placed by the software which is making the false assumption that if it's not "elected" then it was not paid at all.  

[sjrcpa]

The nonresident withholding is withholding on the nonresident owner's share of income. 

The PTET is a tax imposed on the entity's income. IRS specifically ruled the entity can deduct it.

[LauraMac1 · Accepted solution]

Thanks.  This has been driving me a little nuts because it would seem that the IRS wouldn't care what happens at the state level and shouldn't deny an entity the right to deduct a mandatory withholding tax, especially if they're already allowing the PTE which is basically the same thing.

BUT I did some experimenting and I think I see the big difference that makes this non deductible at the entity level. 

When the entity pays the mandatory non-resident withholding tax on a 510 without making the election, the FULL amount of that payment gets passed through to the non-resident shareholders, EVEN IF it's in excess of their actual tax. So, in this sense, it's truly an estimated tax payment which we all know is NOT deductible. ONLY actual taxes are deductible, and that gets figured out on the shareholders' individual returns.  Consequently, there's no refund due at the entity level for an overpayment.  When the election is MADE, the tax expense and amount passed through to the Maryland K-1 is the ACTUAL tax expense which is deductible. So it's the estimated treatment of the non-electing entity that makes it not deductible at the entity level.

Hopefully this post will help someone as I could NOT find any good explanation anywhere. 

[dsocpa]

If an S Corp the amount of PTE tax paid on behalf of the nonresident shareholder is treated as a distribution on the entities books.

[sjrcpa]

For GAAP. Not for tax.

[Accountant-Man]

Non-resident withholding is not a tax deduction; it is an S corp distribution, and the resident owners, if any, MUST take a pro rata distribution, too, physically paid, not paid to the State, to make sure that the S election is not inadvertently terminated.

[sjrcpa]

Agreed. Seems there is confusion about nonresident withholding vs Pass Through Entity Tax, as well as Book vs Tax treatment.

[dsocpa]

Not a deduction if nonresident paid on "behalf" of.  Then on the return as a distribution.  If paid with the form 511 election, then a deduction on federal S corp return.

If GAAP I'm inclined to treat as a state tax expense.

[dsocpa]

If paid on "behalf of" (form 510) I agree.  If the election is filed (form 511) all shareholders are allocated the tax paid in accordance with their ownership.  The PTE becomes an entity level tax with the election in place.  

[sjrcpa]

"If GAAP I'm inclined to treat as a state tax expense"

Our audit dept and a lot of the large firms have concluded differently.

[dsocpa]

On the books of the entity if election is or is not filed the money has to be recorded somewhere on the books whether GAAP or not.  GAAP would apply if the entity is required to maintain their books in accordance with GAAP not tax for financial reporting.   If no election I make an entry to sh distributions.  If an election was filed, I show as an expense, might not be GAAP but the funds are accounted for.  This way the federal return and the accounting records (usually QB) agree.  This is how I handle the nr withholding.

[dsocpa]

In other words the reference was not intended for GAAP financials.  Although, I still question the treatment on GAAP financials as distribution not an expense.