Feds Bless SALT Cap Workaround for Pass-Through Businesses

The U.S. Treasury Department and Internal Revenue Service (IRS) today released a notice regarding proposed regulations to clarify that state and local income taxes (SALT) imposed on pass-through entities (PTE) are not subject to the $10,000 cap on SALT deductions, which applies only to individuals.

The SALT deduction allows taxpayers, as part of their itemized deductions, to subtract state and local income, sales, and property taxes from their federal tax payment. Congress in 2017 capped the SALT deduction at $10,000, a move of particular import in States like Maryland.

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.

Several states — including Maryland — have passed legislation to allow non-corporate businesses to pay state income taxes at the entity level, rather than at the individual level on their owners’ returns. Because the SALT cap applies only to individuals, these actions were intended to help PTEs avoid the cap.

According to a press release from the U.S. Treasury Department:

The forthcoming proposed regulations will apply to these types of income taxes starting today, and will also allow taxpayers to elect to apply the rules described in the notice to specified income taxes paid in a taxable year of a pass-through entity ending after December 31, 2017, and before the date the forthcoming proposed regulations are published in the Federal Register.

“The Department of the Treasury and IRS are taking the necessary steps to provide fairness for America’s small businesses,” said Secretary Steven T. Mnuchin.  “These proposed regulations will offer clarity for individual owners of pass-through entities.”

As previously reported on Conduit Street, Treasury and the IRS have previously issued guidance to block a different type of state workaround to the SALT deduction cap that was aimed at converting state and local taxes to charitable contributions.

Stay tuned to Conduit Street for more information.

Useful Links

Previous Conduit Street Coverage: Feds Squash SALT Cap Workarounds

Previous Conduit Street Coverage: IRS: A SALT Payment’s Still a SALT Payment

Senate Bill 523 –  Income Tax – Pass-Through Entities and Corporations (2020)

U.S. Department of Treasury/Internal Revenue Service: Notice 2020-75