Maryland recently passed new legislation allowing pass-through entities (PTEs) such as partnerships and S corporations to make an election to be taxed at the entity level instead of being taxed at the owner level. This new elective tax could potentially allow for a federal tax deduction for owners who are capped at a $10,000-per-year state tax deduction under the Tax Cuts and Jobs Act of 2017 (TCJA).
The TCJA SALT deduction capOne of the provisions of the TCJA was a new $10,000 state and local tax (SALT) deduction limit for individual taxpayers. In response to this cap, several states began to develop workarounds, with some enacting entity-level tax provisions to “give back” the SALT deduction on business income derived from pass-through entities.
The new Maryland entity-level tax
The new Maryland legislation creates an elective entity-level tax for Maryland PTEs. The tax rate will be the top marginal Maryland tax rate for individuals (5.75%) plus the lowest applicable county tax rate (2.25%), or the Maryland corporate tax rate (8.25%). PTE owners must still report their business income derived from the PTE on their individual federal and Maryland tax returns, but they can claim a credit against Maryland state income tax equal to the tax paid by the PTE. Taxes due under this new regime can’t exceed the distributable cash flow of the PTE. Further, it is important to note that if the PTE makes this election but doesn’t pay the tax, Maryland can collect the taxes due from the owners.
Under the new legislation, distributable income to tax-exempt owners and real estate investment trust (REIT) owners will not be taxed. Owners that are themselves PTEs will not have the option to have their income taxed at the lower level. Instead, the upper-tier PTE must make an independent election to have income taxed at the entity level.
Currently, there are several questions that have yet to be addressed by the Comptroller of Maryland. These questions include but are not limited to: 1) whether the election will carry over when a PTE interest is sold; 2) whether PTEs must make the election on annual basis or the election will be permanent; and 3) how and when a PTE will need to make the election.
What does CohnReznick think?Stay tuned, as the Comptroller of Maryland will need to issue regulations on the various aspects of the law that takes effect July 1, 2020. Maryland residents impacted by this law should confer with their tax advisor to determine whether this “SALT deduction cap workaround” will actually allow for a federal income tax deduction as intended. The fact that owners have to pay if the PTE makes the election then fails to makes this look less like a deductible entity-level tax. In addition, Maryland nonresidents will need to review their resident state tax laws to determine if the Maryland tax paid by the entity will be creditable against their resident state income tax.
Subject matter expertise
JD, Principal, Practice Leader, State and Local Tax (SALT) Services
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