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Hogan’s Heroes: PTE Legislation Signed to Maximize the $10,000 SALT Deduction

For those businesses worried that the Internal Revenue Service (IRS) may challenge the state and local tax workarounds, the agency recently issued Notice 2020-75, which states its intention to issue proposed regulations supporting the use of Pass-Through Entity (PTE) state and local tax (SALT) workarounds.

Background

On February 15, 2001, the World Wrestling Federation heavyweight champion, The Incredible Hulk Hogan, battled against and defeated another wrestler whose name was Irwin R. Scheister (IRS).  It is prudent to note that his initials, IRS, was no coincidence.  IRS was a heel wrestler whose gimmick was that of a former treasury agent whose sole purpose was to wrestler other baby face wrestlers for failing to pay their “fair share” of taxes.  IRS also took pleasure from the boos he received from the wrestling fan audiences.

Twenty years later, on February 15, 2021, another famous Hogan, Governor Larry Hogan, clarified the rules governing the Maryland PTE. When the Tax Cut and Jobs Act (“TCJA”) passed in 2017, individual filers who itemized deductions lost the ability to deduct the entire amount of their state and local tax deduction on Schedule A. Instead, the TCJA limited the SALT deductions to $10,000.  Any additional amount of state tax deduction was disallowed and lost forever.  As a result, many state legislatures decided to develop various techniques to mitigate the benefit of deductions above the $10,000 SALT Limitation. Though these techniques could not expressly change the $10,000 cap reported directly on a taxpayer’s Schedule A, state lawmakers began exploring the ability to effectively increase the tax benefit of the disallowed SALT deduction for taxpayers who were partners, shareholders, or members of pass-through entities.

For those businesses worried that the true IRS would challenge the state and local workarounds, the agency issued Notice 2020-75, which states its intention to issue proposed regulations supporting the use of PTE state and local tax (SALT) workarounds.

Enactment of Laws Benefitting PTE Resident Members

As of July 1, 2020, PTEs with Maryland residents could elect taxation at the entity level; provided those entities have Maryland sourced income for the distributive share of certain resident members of the PTE. (See Maryland Code Ann. Tax-Gen. § 10-102)Note, though, that the tax paid for any taxable year is limited to the total of all members’ share of distributable cash flow from the PTE. (Maryland Code Ann. Tax-Gen. § 10-102.1(d)(3)(II)  Along with imposing this entity-level tax on PTEs, the new law provides for a state tax credit in the same amount to the owners of the PTEs.

Subsequently, the Maryland Comptroller issued Administrative Release 6  (“R6”) in September 2020. The purpose of R6 was to clarify practitioners’ questions, including guidance on the specific filing requirements to make an election.  Unfortunately, R6 was virtually silent on the procedural questions. However, R6 did provide advice on the effect of the election on Maryland residents while expressly prohibiting the election for non-residents. In essence, the legislation recharacterizes the tax paid on behalf of resident members.

Effective 2/15/21, the nonresident members tax does not apply to the pro rata distributive share of a nonresident member that is: (1) itself a pass-through entity formed under the laws of Maryland or qualified by or registered with the Maryland State Department of Assessments and Taxation (SDAT) to do business in Maryland; (2) a real estate investment trust (REIT); (3) an IRC § 501 exempt entity; and (4) a publicly traded pass-through entity that has agreed to file with the Maryland Comptroller an annual information return reporting the name, address, taxpayer identification number, and other required information of each nonresident or nonresident entity member whose distributive share or pro rata share of the pass-through entity’s nonresident taxable income for the taxable year is greater than $500. Finally, the legislation provides for Maryland corporate and individual income tax addition modifications for the amount of the pass-through entity member credit for the share of taxes paid by the pass-through entity.

Conclusion

This taxpayer-friendly development affirms that a pass-through entity’s owners or shareholders would not be limited in the amount deducted for state and local tax purposes. It additionally affirms, although unrelated, there are actually 2 different Hogans who fight for the rights of every man.

For guidance on this complex election, please contact the Withum SALT team to discuss specifics in relation to your business.

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