Taxpayers may have an opportunity to deduct state taxes paid in 2021 by means of their pass-through entity – deductions that might otherwise be limited or lost.
The Tax Cuts and Jobs Act of 2017 (TCJA) limited an individual’s deduction for state and local taxes (SALT) paid to $10,000 ($5,000 for those married and filing separately) as well as other changes.
Following the passage of the TCJA, several states responded by passing specific statutes that allowed businesses that pass-through income to their owners to pay taxes at the entity level, rather than the corporate level (pass-through entity S corporations and partnerships). The result is a full deduction at the entity level and, consequently, a full deduction for the business owners of SALT paid.
In November 2020, the IRS issued Notice 2020-75 stating it would allow pass-through entities to fully deduct state income tax payments on the condition the entity meets certain requirements. This notice clarified that the SALT imposed on and paid by a partnership or an S corporation on its income would be allowed as a deduction by the partnership or S corporation in calculating its non-separately stated taxable income or loss for the taxable year of payment for any payments made after November 9, 2020.
However, only a specified income tax payment is deductible, which according to the IRS is, “any amount paid by a partnership or an S corporation to a state to satisfy its liability for income taxes imposed on the partnership or the S corporation.” For this notice to apply, a state must pass a specific statute providing for pass-through entity-level taxation. Simply allowing a pass-through entity to make withholding tax payments on behalf of owners does not qualify. The IRS stipulates that those withholding tax payments would be treated as payments made by the owners and not as payments made in satisfaction of the pass-through entity’s tax liability.
There are certain complexities to keep in mind for these state tax deductions at the entity level, and they differ by state according to:
- the applicable pass-through tax rate
- how much state credit the owners/partners will be allowed and will actually receive
- the owner/partner’s state of residency and what other state credits will be given
- how and when the elections are made for each state and how the estimated payments are made
Currently, twenty states allow the entity level tax, with varying effective dates (most in 2021), after five states enacted tax legislation in June 2021. Illinois and Massachusetts are two states with bills pending that would allow taxpayers to avoid the $10,000 SALT cap using pass-through entities.
Careful consideration of the benefits of the entity level state tax deduction discussed here should be made, as there are significant disparities among the states. Please consult with your tax advisor to determine how this might benefit you.
Author, Jeff Spiegel, CPA
Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.