The IRS has issued Notice 2020-75 that addresses state and local income taxes imposed on pass-through entities, such as partnerships and S corporations, allowing for a SALT Cap workaround. The Tax Cuts and Jobs Act (which went into effect for tax years starting 1/1/18) limited the amount of state and local taxes an individual could deduct on Schedule A of their 1040. The limitation was set at $10,000 and has remained the same.
Since the introduction of that legislature, states have been trying to come up with a SALT cap workaround so that the taxes would be captured at the entity level as opposed to passing them through to the partners/shareholders. Connecticut was the first state to introduce a pass-through entity (PTE) tax, effective 1/1/18. They require the PTE to pay an entity-level tax of 6.99%.
Salt Cap Workaround for Pass-Through Entities
Several states have started to follow Connecticut’s lead and have introduced a pass-through entity tax. Some of the other states that, as of 2020, have enacted this type of tax include Louisiana, Maryland, New Jersey, Oklahoma, Rhode Island, and Wisconsin. Each state has separate rules and rates for this tax and different ways of electing to pay the tax. Until this week, the IRS has not issued any guidance on this workaround being valid.
The Notice states that the IRS will allow the workaround and that PTE tax payments will be allowed as an entity-level deduction. The regulations will apply to specified income tax payments made on or after November 9, 2020. It also states that the rules would pertain to specified income tax payments made in a tax year ending after 12/31/17 and made before 11/9/20, provided that the payment is for an entity-level tax.
Important: Keep in mind this only applies to states that have a PTE tax. If a state still requires an individual to pay the tax, that tax is not deductible at the entity level.
This Notice from the IRS could result in considerable tax savings for partners/shareholders who have been limited to the SALT cap of $10,000. The IRS still needs to issue the regulations related to this Notice, but individuals should consider electing to have their PTE pay the state income tax at the entity level in states that allow it.
Contact us for assistance
The Hoffman Group is currently researching this topic, and further guidance will be coming soon. If you have any questions, please feel free to contact Mike Price (MPrice@Hoffmancpas.com) or Stephen Harrington (SHarrington@Hoffmancpas.com) for more information, or call us at 443-320-4101.
Author: Megan O’Donnell