The new Connecticut pass-through entity tax applies to S corporations, partnerships, and limited liability companies. The tax is imposed at 6.99%, the highest personal income tax rate, on most pass-through entities’ Connecticut source income. Individual shareholders/partners then take a 93.01% credit against their Connecticut tax liabilities. Thus, a nonresident who only pays tax to Connecticut on the pass-through entity’s source income likely owes no additional Connecticut tax.
The IRS confirms the Connecticut pass-through entity tax is a legitimate, deductible entity-level business expense for federal income tax purposes. By default, LLCs themselves do not pay federal income taxes, only their members do.
The 2023 changes make the pass-through entity tax optional and require electing entities to use the alternative base to calculate taxable income. It remains unclear whether the IRS will challenge the deductibility of the tax.
After the federal deduction limitation for state and local taxes, taxpayers sought workarounds. Pass-through entity taxes received the desired IRS approval. As of May 2023, 36 states and New York City adopted some form of pass-through entity tax law. For many taxpayers, the mechanisms and benefits are not fully understood.