Bill Summary – FastDemocracy

SB 523
                                  Department of Legislative Services
                                             Maryland General Assembly
                                                   2020 Session
                                         FISCAL AND POLICY NOTE
                                              Enrolled - Revised
Senate Bill 523                                 (Senator Guzzone, et al.)
Budget and Taxation                                                                                            Ways and Means
                        Income Tax – Pass–Through Entities and Corporations
This bill authorizes a pass-through entity (PTE) to elect to be taxed at the entity level for
the income tax. A PTE must pay the tax imposed on nonresident entity members as required
under current law. An individual or corporation may claim a tax credit against the State
income tax equal to the tax paid by a PTE on the member’s share of the PTE’s taxable
income. Additionally, the bill alters the number of employees that a worldwide
headquartered company must have for purposes of the single sales apportionment
exemption. The bill takes effect July 1, 2020, and applies to tax year 2020 and beyond.
                                                      Fiscal Summary
State Effect: General fund, Transportation Trust Fund (TTF), and Higher Education
Investment Fund (HEIF) revenues and TTF expenditures may decrease beginning in
FY 2021. General fund expenditures increase by $226,200 in FY 2021 due to
implementation costs at the Comptroller’s Office. Future years reflect annualization and
ongoing costs.
      (in dollars)               FY 2021               FY 2022                FY 2023               FY 2024                FY 2025
   GF Revenue                             (-)                    (-)                   (-)                   (-)                    (-)
   SF Revenue                             (-)                    (-)                   (-)                   (-)                    (-)
   GF Expenditure                   $226,200                $99,700              $101,800              $105,300               $109,000
   Net Effect                     ($226,200)              ($99,700)            ($101,800)            ($105,300)             ($109,000)
Note:() = decrease; GF = general funds; FF = federal funds; SF = special funds; - = indeterminate increase; (-) = indeterminate decrease
Local Effect: Local highway user revenues may decrease beginning in FY 2021. Local
expenditures are not affected.
Small Business Effect: Minimal.
                                          Analysis
Bill Summary:
Pass-through Entities
The tax for a PTE that elects to be taxed at the entity level is the sum of the lowest county
tax rate imposed and the top marginal State tax rate for individuals applied to the sum of
each individual member’s distributive or pro rata share of the PTE’s taxable income. For
entity members, the tax rate is equal to the State corporate income tax rate. The tax required
to be paid by a PTE that makes the election may not exceed the sum of all of the members’
shares of the PTE’s distributable cash flow.
Single Sales Factor Apportionment Exemption
The bill alters the number of employees that a worldwide headquartered company must
have for purposes of the single sales apportionment exemption. If the parent corporation is
a franchisor, it must be part of a group of corporations that employ at least 400 full-time
employees at the parent corporation’s principal executive office that is located within the
State, among other requirements, to be considered a worldwide headquartered corporation.
Current Law: The PTE income tax return is generally an information return. The entity’s
income or loss is passed through to the separate members for taxation purposes. If a PTE
is owned by a nonresident, it may be subject to the nonresident PTE income tax. A credit
may be claimed on a member’s income tax return for any tax paid on behalf of a
nonresident member by the PTE. The PTE may elect to file a composite return on behalf
of qualified nonresident individual members under which the entity would be the agent to
receive any refund or to pay any tax due. Nonresident fiduciary and nonresident entity
members may not participate in the filing of the composite return.
Single Sales Factor Apportionment
Prior to tax year 2018, corporations were generally required to use either a three-factor
apportionment formula of payroll, property, and sales, with sales double weighted or, in
the case of a manufacturing corporation, a one-factor formula based on sales, referred to as
a single sales factor formula. The apportionment factor is then multiplied by the
corporation’s modified income to determine Maryland taxable income.
Chapters 341 and 342 of 2018 phase in a requirement that all corporations subject to the
corporate income tax, with an exception for specified worldwide headquartered companies,
use a single sales factor formula to apportion income to the State. In general, sales represent
60% of the final apportionment factor in tax year 2018, 66.67% of the final apportionment
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factor in tax year 2019, 71.42% of the final apportionment factor in tax year 2020, 75% of
the final apportionment factor in tax year 2021, and 100% of the final apportionment factor
in tax year 2022 and beyond. Corporations engaged primarily in manufacturing activities
must use a single sales apportionment factor.
A corporation may elect annually to use a three-factor formula that incorporates property,
payroll, and a double-weighted sales factor if the corporation included in a group of
corporations, including a parent corporation, is a worldwide headquartered company that
filed a federal corporate income tax return for the taxable year, filed a specified form with
the Securities and Exchange Commission, has its principal executive office in the State,
and employs at least 500 full-time employees during a specified period.
To determine the Maryland modified income of a corporation or group of corporations that
is a worldwide headquartered company that filed a federal corporate income tax return for
the taxable year, gross income from intangible investments, including dividends, interest,
royalties, and capital gains from the sale of intangible property, must be included in the
calculation of the numerator based on the average of the property and payroll factors.
Background: A PTE is a business structure that avoids the double taxation imposed on
an ordinary corporation. A corporation’s income generally is taxed at the corporate level
and taxed again at the individual level when income is distributed as dividends (cash) to
the owners or shareholders. However, PTE income “flows through” and is allocated to the
owners of the entity, who pay income tax at the individual level on this income. Owners
may choose the type of entity to form for a variety of reasons, including the number of
owners, liability protection, profit distribution, ease of formation, and tax treatment.
In order for a business to be treated as a PTE, the entity must organize under State law and
make an election to file as a PTE on the entity’s federal income tax return. PTEs generally
fall within one of five categories: sole proprietorship; general partnership; limited
partnership; limited liability company; and S corporation (a corporation that is taxed as a
PTE).
Federal Tax Cuts and Jobs Act and States’ Response
Under the federal Tax Cuts and Jobs Act of 2017, the maximum state and local tax
deduction is limited to $10,000 – $5,000 for married taxpayers filing separately – in
aggregate of income or sales taxes, real property taxes, and certain personal property taxes
through tax year 2025. In response to this limitation, several states have enacted or
proposed legislation subjecting PTEs to an entity-level income tax in order to allow state
and local taxes to be deducted notwithstanding the limitation. Under current
Internal Revenue Service (IRS) interpretations, taxes paid by entities are fully deductible
and not subject to the $10,000 (or $5,000) limitation.
SB 523/ Page 3
Connecticut, Louisiana, New Jersey, Oklahoma, Rhode Island, and Wisconsin have
enacted legislation creating PTE tax plans. The IRS and the U.S. Treasury have not issued
formal guidance on these newly enacted state-level PTE tax plans. However, the IRS
published regulations that have disallowed workarounds related to government-created
charitable funds for a variety of programs whereby donors can receive a state tax credit in
exchange for donations.
The Comptroller’s Office estimates the bill will reduce federal taxes by approximately
$425 million for 139,000 households (although this estimate includes Schedule C income,
which is not applicable to the bill).
State/Local Revenues: Under the bill, PTEs may elect to pay taxes on behalf of all
members. PTEs that elect to pay taxes will pay a tax rate of 8.25% for corporate PTE
members’ shares of taxable income, and these corporations will receive a credit for the
taxes paid. PTEs making the election also pay tax on behalf of individual PTE members at
the highest marginal State income tax rate (5.75%) and the lowest county tax rate (2.25%
in tax year 2020). Thus, individual taxpayers receive a State credit for the taxes paid
attributable to the 5.75% State tax rate and for the taxes paid attributable to the lowest
county tax rate imposed. Accordingly, this provision of the bill is revenue neutral for PTEs
paying tax on members’ share of taxable income.
Single Sales Apportionment Exemption
Approximately a dozen or fewer corporations will be able to elect to be exempt from the
single sales apportionment requirement under the bill. These companies may elect annually
to use a three-factor formula that incorporates property, payroll, and a double-weighted
sales factor. Thus, general fund, TTF, and HEIF revenues may decrease beginning in
fiscal 2021 to the extent that these companies elect to use the double-weighted sales factor
apportionment formula. The Comptroller’s Office advises that they are not able to disclose
the fiscal impact of the bill due to taxpayer confidentiality; however, they do not expect
the bill to have a significant fiscal effect and the revenue loss, if any, is likely to be less
than $5.0 million annually.
Local governments receive a portion of corporate income tax revenues as local highway
user revenues through capital transportation grants. Thus, local highway user revenues may
decrease beginning in fiscal 2021 to the extent that corporate income tax revenues decrease.
State Expenditures: General fund expenditures for the Comptroller’s Office increase by
$226,200 in fiscal 2021, which assumes a six-month start-up delay from the bill’s
July 1, 2020 effective date. This estimate reflects the cost of hiring two revenue examiners
to process and approve tax payments and credits. It also includes $165,000 for one-time
data processing changes to the income tax return processing and imaging systems and
SB 523/ Page 4
system testing. The estimate includes salaries, fringe benefits, one-time start-up costs, and
ongoing operating expenses.
         Positions                                                             2
         Salaries and Fringe Benefits                                    $50,748
         Data Processing Changes                                         165,000
         Other Operating Expenses                                         10,415
         Total FY 2021 State Expenditures                               $226,163
Future year expenditures reflect full salaries with annual increases and employee turnover
and ongoing operating expenses.
A portion of TTF revenues are used to provide capital transportation grants to local
governments. To the extent that TTF revenues decrease as a result of taxpayers altering
their apportionment method on the corporate income tax, TTF expenditures decrease by
13.5% of the TTF revenue decrease beginning in fiscal 2021 (9.6% beginning in
fiscal 2025). TTF revenues also fund the State capital program; thus, a decrease in TTF
revenues decreases expenditures for the State capital program.
                                Additional Information
Prior Introductions: None.
Designated Cross File: None.
Information Source(s): Comptroller’s Office; Tax Analysts; Tax Notes; Internal Revenue
Service; Department of Legislative Services
Fiscal Note History:      First Reader - February 11, 2020
rh/rjr                    Third Reader - March 17, 2020
                                 Revised - Amendment(s) - March 17, 2020
                          Enrolled - April 6, 2020
                                 Revised - Amendment(s) - April 6, 2020
Analysis by: Heather N. MacDonagh                       Direct Inquiries to:
                                                        (410) 946-5510
                                                        (301) 970-5510
SB 523/ Page 5
Statutes affected: 
Text - First - Income Tax - Pass-Through Entities - Imposition of Tax: 10-102.1 Tax General, 10-210 Tax General, 10-106.1 Tax General, 10-105 Tax General, 10-105 Tax General, 10-701.1 Tax General, 10-102.1 Tax General, 10-706 Tax General
Text - Third - Income Tax – Pass–Through Entities and Corporations: 10-102.1 Tax General, 10-210 Tax General, 10-106.1 Tax General, 10-105 Tax General, 10-105 Tax General, 10-402 Tax General, 2-017 Tax General, 10-701.1 Tax General, 10-102.1 Tax General, 10-703 Tax General, 10-706 Tax General, 10-311 Tax General, 2-018 Tax General
Text - Enrolled - Income Tax – Pass–Through Entities and Corporations: 10-701.1 Tax General, 10-102.1 Tax General, 10-210 Tax General, 10-106.1 Tax General, 10-105 Tax General, 10-105 Tax General, 10-402 Tax General, 2-017 Tax General, 10-701.1 Tax General, 10-102.1 Tax General, 10-703 Tax General, 10-706 Tax General, 10-311 Tax General, 2-018 Tax General