Taxation of PTE’s: Working Around the $10,000 SALT Cap
Are your itemized deductions limited by the $10,000 SALT cap? New IRS guidance and state filings could provide a solution.
One of the changes made by the 2017 Tax Cuts and Jobs Act limits the amount of state taxes deductible on an individual’s Schedule A to $10,000. Long story short – if you pay a lot of state tax, it reduces the amount you can deduct – that increases the tax you pay!
Not surprisingly, as soon as this was in place, states with high tax rates were trying to circumvent it. An initial solution involved allowing individuals to contribute to a “charitable” fund and take a corresponding credit to state taxes. This would have allowed individuals to deduct the amount as a charitable contribution rather than taxes on Schedule A, since contributions are much less likely to be limited. However, the IRS rejected this method since the contributions were just taxes in disguise.
Pass-Through Entity Regulations
In November 2020, the IRS issued Notice 2020-75. This notice offers proposed regulations stating the IRS will permit pass-through entity (PTE) level taxes, which allow owners of pass-through businesses to pay an additional state tax at the business level with an offsetting credit against their individual income tax liability. In simpler terms, business owners can pay state tax through their business so it is deductible there rather than on their 1040 where it could be limited.
Several states have already enacted PTE taxes. Connecticut has made the return mandatory, whereas other states including Alabama, Arkansas, Georgia, Idaho, Louisiana, Maryland, New Jersey, New York, Oklahoma, Rhode Island, and Wisconsin have voluntary PTE taxes. For the voluntary PTE taxes, some states require an election to be made, which may be irrevocable. More states are expected to follow this trend in 2021, including California which is currently in legislation.
Businesses will want to consider the effects before electing the PTE tax, as it could be detrimental to certain business owners. Taxpayers who file in multiple states can often get a credit for taxes paid to other states. However, many of these credits are tied to income taxes and won’t apply to taxes that are reclassified as entity-level payments. This could result in the entity paying PTE tax and the nonresident partner getting no credit, which could negate any benefit from deducting the PTE tax paid.
As with most tax issues, taxpayers will have to look at each state in question and their own personal fact pattern to determine whether electing a PTE tax will be beneficial to them. McKonly & Asbury can assist in these determinations. For more information on McKonly & Asbury’s State and Local Tax Services or for questions regarding this article, please contact Lindsey Waltemyer, SALT Leader and Tax Manager, at lwaltemyer@macpas.com.
July 29 Webinar: 2021 State and Local Tax Update
Join us on Thursday, July 29 at 2pm EST for our 2021 State and Local Tax Update webinar! Mark Heath, Partner and Director of Tax Services along with Lindsey Waltemyer, Manager and SALT Leader will be discussing the state tax implications of recent federal tax changes, including those changes related to COVID-19. Other topics to be covered include a discussion of states imposing new pass-through entity taxes; the various tax consequences of having employees working from home in other states; as well as voluntary disclosure agreements and when they can be beneficial to taxpayers. The webinar will round out with some state tax updates from the past year and we will look at state comparisons and the trends in state taxation going forward.
You can learn more and register by clicking here.
