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1.461-4(g)(6)(i) upon meeting three and deductions. If basis is less than the list of areas practitioners need to be con-
tests: (1) all the events have occurred nondeductible expenses, the portion in cerned about. Additional areas include:
that fix the fact of the liability; (2) the excess of basis is not carried forward.19 ■ Is the PTE tax refundable to the
amount can be determined with rea- Thus, in the right circumstances, the S corporation, or to the shareholders,
sonable accuracy; and (3) payment has shareholder’s state stock basis may avoid if overpaid?
occurred. Accrual-method taxpayers can a reduction for this item. ■ Are PTE tax underpayments by the
adopt the recurring-item exception of Other issues: In addition to the S corporation subject to penalties and
Regs. Sec. 1.461-5 and deduct taxes paid above issues, S corporations may have a interest?
within 8½ months after the end of the particular consideration with regard to ■ Is the PTE tax credit refundable to
tax year. the allocation of the PTE tax deduction the shareholders if they are not able
For states like New York in which and the credit on the state return. S cor- to use it all? Does it carry over, and
the PTE election is made within the porations are required to allocate income for how long?
tax year, there does not seem to be any on a “per share, per day” method. If all ■ Do deductions such as charitable
bar to meeting the first test. By mak- shareholders are eligible to consent to contributions reduce the PTE tax
ing the election, the liability is fixed. the PTE tax, and the deduction can be base?
However, in states like California where allocated in this way, no problems arise. ■ Do deductions that are classified as
the election is made the next year on However, if one or more shareholders nonbusiness under the state rules
a timely filed (with extensions) return, are not eligible, the question arises as to reduce the PTE tax base?
the liability is not fixed as of the end of whether a second class of stock will be ■ Are there limits on the shareholders’
the year. Thus, the first test is not met created by allocating the PTE tax and ability to use the PTE tax credit on
and therefore economic performance, credit only to the electing shareholders. their state returns?
and the recurring-item exception, would Similarly, where one or more share- ■ What is the effect on the Sec. 199A
normally be irrelevant. The notice ap- holders are nonresidents of the PTE qualified business income deduction?
pears not to take the general rules for tax state, the state may allow a credit ■ Does having the tax paid by the
accrual-method taxpayers into account. against tax only on apportioned income entity affect estate planning for
Practitioners will need to assess the level of the S corporation. This will result in a the shareholder? Specifically, if
of risk they and the client are comfort- non–pro rata allocation of the PTE tax installment sales to defective grantor
able with in claiming the deduction for deduction and the credit. trusts have been planned based on
accrual-method taxpayers. For example, if Jim is a nonresident distributions from the S corporation,
Character of PTE tax payment of California and Mary is a resident, and what will the impact be when part of
on the state return: Unlike a com- they own JM S corporation 50-50, then the planned distribution for taxes is
posite or withholding payment, which if JM’s total net income is $1,000 and diverted to the PTE tax?
is treated as a distribution for both the California-source income is $800, Jim Had the state and local taxes deduc-
federal and state returns and does not will be taxed in California on $400. His tion cap been increased in legislation
reduce any sort of income, the PTE tax PTE tax under California rules would last year, many clients and practitioners
is designed to reduce federal taxable be 9.3% of $400, or $37.20. Mary’s PTE would be sitting out the PTE tax elec-
income as a deduction. It would appear, tax would be $46.50. tion until the technical questions were
then, that similar to an entity-level state The notice does not provide guidance resolved. Since it was not increased,
income or franchise tax, the PTE tax on whether allocating the PTE tax ac- practitioners need to tread carefully and
will normally be added back to arrive cording to these calculations will create evaluate each client’s situation.
at state taxable income and be reported a second class of stock. Unless additional
on the state Schedules K-1 as a perma- guidance is issued, practitioners should Reporting of compensation,
nently nondeductible item. be cautious about PTE elections for passthrough of income must
For S corporations, such nondeduct- similar fact patterns. be consistent
ible expenses reduce shareholder stock General considerations: Unfor- In Ward,20 the Tax Court addressed fa-
basis after distributions and before losses tunately, the above does not exhaust the miliar issues surrounding S corporation

19. Unless the election under Regs. Sec. 1.1367-1(g) is made. 20. Ward, T.C. Memo. 2021-32.

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