The benefits of PTET elections in M&A transactions

A significant provision of the Tax Cuts and Jobs Act of 2017 capped state and local tax (SALT) deductions at $10,000. That constraint proved detrimental to many people who held an ownership interest in either a partnership or an S corporation.

State PTET elections were created to help mitigate the negative effects of the SALT-instituted cap. As of February 2023, 29 states enacted PTET elections, and several more have pending legislation to do so. At Crowe Expertise Week for private equity, our thought leaders explained some of the considerations for such elections in M&A transactions.

Why PTET elections matter in M&A transactions

For sellers in M&A transactions, PTET elections can produce significant savings when large gains might be taxable either in an individual seller’s resident state or, depending on the structure of the transaction, in states where the pass-through entity has a significant apportionment.

In deemed asset sales, buyers often are expected to “gross up” the seller for their incremental tax cost, with the seller hoping to arrive at after-tax cash proceeds that are the same as if they were selling stock. Buyers often are willing to gross up the sellers in order to get a step-up in tax basis under an actual or deemed asset sale.

Using PTET elections when selling assets can provide a strong financial advantage to sellers, and depending on the circumstances and the states involved, could reduce or even eliminate the detriment to doing an asset deal for the seller.

Preparing to apply PTET elections to M&A transactions

As you consider how to take advantage of PTET elections in an M&A transaction, it’s important to keep the following key points in mind:

• Conversations between buyer and seller about potential PTET elections to be made should happen as early as possible in the M&A process.
• The benefit of PTET election is not guaranteed in aggregate or for each partner and shareholder separately. Federal and multistate modeling that reflects the circumstances of partners and shareholders, as well as the operating business, generally is needed to confirm the best approach for making PTET elections in various states. 

1. Tax is computed and paid at the pass-through entity level.
2. Individuals typically receive a state tax credit for their share of taxes paid by the entity in that state, though some states provide for an income exclusion in lieu of a credit.
3. The pass-through entity is able to deduct PTET as taxes and licenses in determining ordinary business income.
4. Individuals receive benefit through lower federal income reported on their K-1s.

Listen to the full session here