Passing the SALT: Creative Workarounds on the Horizon?
While the much higher standard personal deduction that was a key part of the Tax Cuts and Jobs Act (TCJA) of 2017 was a boon for many taxpayers, the law also contained a provision that many higher-income individuals see as a poison pill: the $10,000 limitation on deductions for state and local taxes (SALT). This provision stipulates that filers who itemize their deductions are limited to a $10,000 deduction on their federal tax return for payment of state and local taxes.
It’s easy to see how the effect of this requirement falls more heavily on the wealthy, who are much more likely to own multiple homes or business real estate (property taxes) and purchase expensive items (sales taxes). The limitation also includes state and local income taxes, which are borne at higher levels by those with greater incomes. Finally, the $10,000 limit applies both to single filers and married couples filing jointly, effectively limiting married persons to a $5,000 deduction for each partner.
However, a number of states have proposed creative workarounds for this limitation, including the possibility of allowing state tax obligations to be paid as a charitable contribution, which would make them more likely to be deductible. The IRS publicly frowned on this, so some states—Louisiana, Oklahoma, Rhode Island, Wisconsin, New Jersey, Maryland, and Connecticut—managed to find a different structure. At this point, it seems that the IRS may view the current effort more favorably.
The workaround would allow individual owners of a pass-through businesses like a sole proprietorship, a partnership, or an S corporation to have the business—not the individual taxpayer—pay the SALT taxes. The business would then take a deduction for these expenditures, and the value of the deduction would be passed through to the individual business owners. But will the IRS permit this? On November 9, 2020, the IRS released Notice 2020-75, which agreed that pass-through businesses could claim deductions at the business level for state and local income tax paid, provided that state laws existed that would shift the tax burden from individual owners to the business entity.
If this strategy holds up to further scrutiny, it seems likely that other states, especially those with state and local income taxes or above-average property tax structures, might follow suit. This would be a tremendous benefit to higher-income taxpayers, many of whom are also owners of pass-through businesses. The key will be for state legislatures to enact laws enabling the business to accept the legal responsibility for such taxes paid by their owners. It could also create a modest boom in the popularity of pass-through business entities.
We work with owners of businesses of all sizes to develop tax-efficient, market-tested strategies for maximizing benefit to stakeholders. If you would like to learn more, please contact us. For a quick roundup of the latest on filing schedules and other tax information for the 2021 season, click here.