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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

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.

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

Initially, many states explored the possibility of converting the limited SALT deduction into a charitable contribution deduction. Unfortunately, the Internal Revenue Service (the “IRS”) issued guidance, effectively disallowing this particular approach.  Despite the IRS’s position on this matter, many states explored the possibility of converting an individual’s SALT deduction into a PTE-level deduction that would increase the overall tax benefit to the PTE owner.

Enactment of Laws Benefitting PTE Resident Members

Effective July 1, 2020, Maryland Code Ann. Tax-Gen. § 10-102 provides for PTEs with Maryland residents to elect taxation at the entity level; provided those entities have Maryland sourced income for the distributive share of certain resident members of the PTE. 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. 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.

For non-residents, as under prior rules, the PTE still pays the tax on behalf of the PTEs non-resident or non-resident entity members. Thus, the tax paid on behalf of a PTE’s non-resident member is allocable to the upper-tier partners. The non-resident PTE member must file a Maryland income tax return to flow-up the credit for non-resident tax paid. Additionally, R6 details the differences in how the election would work with an S corporation versus other PTEs.

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.

IRS Intends to Greenlight Full State Income Tax Deduction for Pass-Throughs

Authors: Jeffrey A. Clayman, CPA, JD, LLM-Tax, jclayman@withum.com | Bonnie Susmano, JD, bsusmano@withum.com

SALT Updates

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