NEW Tax Law Allows Certain Business Owners a Workaround for the $10,000 Cap on the State and Local Tax Deduction

Just a note to readers—if you are not an owner of a partnership or S-corporation (pass-through entity or PTE), just quit here, unless you are a real tax nerd!

As you are likely aware, the 2017 Tax Cuts and Jobs Act included a provision that greatly increased the personal standard deduction and limited the deduction for state and local taxes – known as SALT – to $10,000 ($5,000 for single filers). This cap has impacted many of our clients owning pass-through entities, as they are generally limited on the amount of state tax they can deduct.

In response to this law, a growing number of states have passed their own laws allowing pass-through entities (PTEs), such as partnerships and S corporations, a workaround.

Nearly half of US states (including Minnesota, Idaho, and California) have implemented laws that allow a PTEs to elect to pay state income taxes at the entity-level (and deduct those state taxes for federal purposes); rather than paying the state tax with the personal income tax returns of the individual owners as has been done previously. This results in tax savings for almost all S-Corporation and partnership owners – considerable tax savings in some cases.
Each of the states that have adopted a SALT tax workaround has adopted unique laws, so this does not work the same in each state. However, in general, the process will work as follows:

  • The PTE (partnership or S corporation) will elect to pay the state tax at the entity level.
  • PTE will pay the tax, at a rate determined by the state, on behalf of the owners. The tax will generally be due by the due date of the PTE return (usually 4/15).
  • The payment will flow through on the K-1 resulting in a refundable credit against state tax on each owner’s state tax return.
  • The treatment varies by state with some offering a credit (either refundable or non-refundable), or as a reduction in the taxable income to the state equal to the owner’s share of income from the PTE.
  • The net of all of this is that the PTE will deduct that state tax paid for federal purposes. That deduction will reduce the federal taxable income and federal tax, effectively circumventing that SALT tax limitation on income arising from a pass-through entity.

For most of our clients, there seems to be no downside to making the election and taking advantage of the workaround. It’s important to know that this will also help those who can’t itemize their deductions, as it will make the state tax paid by the PTE deductible for federal purposes regardless of whether they can itemize or not.

The states that have passed a workaround of one form or another are Alabama, Arkansas, Arizona, California, Colorado (2022), Connecticut, Georgia, Idaho, Louisiana, Maryland, Minnesota, New Jersey, New York, Oklahoma, Rhode Island, South Carolina, Wisconsin. Other states are working on doing something similar and we will keep following the progress of this legislation around the country.

This will be a major change in how we work with partnerships and S corporations in this upcoming tax season. We are committed to ensuring that our clients pay as little tax as legally allowed and this is one more tool that we have available.

Let Us Help You.
With any tax law change, it’s important to revisit your full financial roadmap.  Please contact our office today to discuss your specific situation. As always, planning ahead can help you maximize your tax savings and position you and your business for greater success.