Some Business Owners Now Eligible for Workaround for State and Local Tax Deduction Cap

Of all the changes brought about following 2017’s tax reforms, the $10,000 cap placed on property owners’ ability to deduct state and local taxes from their federal income liability was one of the least popular. This is especially true in California, New York, and New Jersey where those taxes — known by the acronym SALT —are particularly high.

Though many had hoped that Congress and President Joe Biden would repeal that part of the tax law, it hasn’t happened yet, and no proposals have been submitted to suggest it will happen in the future. Some individuals have devised creative strategies in hopes that they would pass muster, but so far they’ve largely been blocked. In response, several states are creating workarounds, and one type is being extended to pass-through businesses like partnerships, S-Corporations and some LLCs.

According to the American Institute of CPAs (AICPA), the states that have passed legislation in support of these strategies currently include Alabama, Arkansas, Arizona, California, Colorado, Connecticut, Georgia, Idaho, Louisiana, Maryland, Minnesota, New Jersey, New York, Oklahoma, Rhode Island, South Carolina and Wisconsin, and more are likely to follow as Illinois, Massachusetts, Michigan, North Carolina, Oregon and Pennsylvania currently have their own versions of the legislation pending. Guidance on these laws was published by the IRS in November of 2020, signaling that there will be no objections raised to their use.

Experts analyzing the programs have indicated that though the workarounds will provide welcome relief to many qualifying businesses, they are not going to be a fit for everybody.

How pass-through businesses can benefit from SALT tax limit workarounds

Pass-through businesses are those whose profits glow directly to their owners’ individual tax returns. The majority of companies in the United States fit this definition, and the states offering the work around have devised a state levy that would allow the company to pay a portion of the business owners’ state income taxes instead of the owners themselves. In some cases, the levy would be paid for by the business and in others the payment would be processed via an entity-level tax deduction. Still others can receive a credit that would offset the taxes that were paid.

To get a better sense of how the system would work, California’s Governor Gavin Newsom just signed a law letting businesses choose to submit an additional 9.3% tax levy on each owner’s share of their company’s net income and then offsetting that tax levy with an equivalent credit on their California income tax return. The system means that pass-through income would be used to prepay state taxes.

Will the workaround work for your business?

Though the system is effective for many business owners, it won’t work for all of them, and that’s unfortunate because the $10,000 limit has added significant tax liability for those who are already paying a lot in state and local taxes. To determine whether the workaround is right for you, you need to look at both your entity and personal taxes. Factors such as whether you spend enough to itemize and what tax bracket you are in will substantially affect whether pursuing the bypass is worthwhile. The question can be complicated, and best answered by a tax professional who can do all of the pertinent calculations and let you know whether you will benefit or not.