Plans for pass-through entity SALT cap workaround

The Treasury and the IRS plan to release proposed regulations that will allow a pass-through entity’s (S corporations and partnerships) state and local income tax deduction in determining the entity’s non-separately stated taxable income or loss for the taxable year paid or accrued, according to their recently released Notice 2020-75.

What does this mean?

It means the state and local income taxes imposed on a pass-through entity paid or accrued in the taxable year will be deductible as an ordinary and necessary business expense.  

Notice 2020-75 defines “Specified Income Tax Payment” as “any amount paid by a partnership or an S corporation to a State, a political subdivision of a State, or the District of Columbia (Domestic Jurisdiction) to satisfy its liability for income taxes imposed by the Domestic Jurisdiction on the partnership or the S corporation.”

The deduction will be allowed whether the imposition of the income tax is mandatory or the result of an election by the entity.

The “Specified Income Tax Payments” do not constitute an item of deduction that a partner or S corporation shareholder considers separately in applying the SALT deduction limitation as an individual.

The proposed regulations will apply to any Specified Income Tax Payments made on or after Nov. 9, 2020, and taxpayers will also be allowed to apply the rules to such payments made in a tax year ending after Dec. 31, 2017, and made before Nov. 9, 2020.

What states are impacted?

Connecticut imposed a mandatory income tax on pass-through entities for tax years starting on or after Jan. 1, 2018.

Other states providing elective versions of the Connecticut workaround are:

• Louisiana: Tax years beginning on or after Jan. 1, 2019
• Maryland: Effective July 1, 2020, for tax years beginning after Dec. 31, 2019
• New Jersey: Tax years beginning on or after Jan. 1, 2020
• Oklahoma: Tax years beginning on or after Jan. 1, 2019
• Rhode Island: Tax years beginning on or after Jan. 1, 2019
• Wisconsin: Tax years beginning on or after Jan. 1, 2018

Other states are likely to follow with additional SALT CAP workarounds based on this Treasury notice.

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