Opinion: Converting payments into deductions with pass-through entity tax credits

Katie Porter

When it comes to tax, there is one main question on every business owner’s mind: How can I minimize it? Good news: The Missouri pass-through entity tax, also known as a SALT workaround, is an increasingly popular avenue for state and local tax savings among Missouri business owners. This election is a way to create a state tax expense deduction on your business tax return that lowers your federal taxable income.

Missouri pass-through entity tax, or PTE, is only available to businesses that are taxed as a pass-through entity (either an S corporation or a partnership). Generally, pass-through entities stay true to their name and pass through any income or losses earned by the business to the tax returns of their owners. However, if you elect to become an affected business entity subject to Missouri PTE tax, you’re electing to tax that entity’s income or losses at the Missouri business level instead. This may not initially sound helpful, but state income tax imposed on a business (rather than on the owners) is a deductible business expense on the federal tax return.

Let’s look at a simple illustration. If your federal business taxable income is $100,000 this year, then, without the election, you will report $100,000 of taxable business income on your personal return. However, with the election, after calculating Missouri PTE tax of $3,960 to be paid by your business, you would report $96,040 of taxable business income on your personal federal return. Depending on your tax bracket and certain other factors, this could save you over $1,000 in federal tax. The lower your business taxable income and the lower your marginal personal tax bracket, the less benefit you receive from this election. It is important to weigh the added tax preparation complexity and possible cash flow disadvantages against the amount of benefit received. This business-level election is one that all owners of the entity should agree on, as each owner’s unique tax situation could reduce or erase their hoped-for tax savings.

If you are a resident of Missouri, your portion of the Missouri PTE tax paid at the level of the entity becomes a Missouri tax credit on your personal return that can be applied against any Missouri personal tax liability for the year. In this way, the cash paid at the level of the entity is not lost but is merely recharacterized as a credit on your personal return to keep the Missouri effect neutral. However, be aware that this is a nonrefundable credit, so if other factors on your personal Missouri return cause you to be overpaid for the year, the credit will not be refunded but will instead be carried forward to next year’s tax return. This possibility of “unreachable cash” is a disadvantage to keep in mind as you contemplate this tax strategy. If you have owners who are not residents of Missouri, there is a possible added benefit. Nonresident owners that do not have any other Missouri income do not have to file a Missouri nonresident return.

The federal deduction benefit is available for the tax year in which the Missouri PTE payments are paid, so to realize the benefit on the owners’ 2024 personal tax return, it is recommended that an anticipated Missouri tax payment be made by the entity before Dec. 31. This anticipated 2024 payment would be treated as a prepayment on the 2024 MO-PTE form when it is filed. To realize the benefit in 2025, you can wait to pay the entire balance due with the 2024 MO-PTE form at the time it is filed in 2025.

The main benefits to consider are the lowering of federal business taxable income and the possibility of no filing requirement for nonresident owners. The main disadvantages to consider are the timing of cash flow at the level of the entity, the nonrefundable nature of the credit at the level of the owners and the possibility that certain owners’ tax situations will yield low to no benefit. Fortunately, this is an annual election, which means you can choose to only make the election in years that it would be advantageous. Reach out to your tax adviser to find out if this election could benefit you.  

Katie Porter is a CPA and manager at Elliott, Robinson & Co. LLP. She can be reached at
kporter@ercpa.com.