State And Local Tax (“SALT”) Cap Workaround
State And Local Tax (“SALT”) Cap Workaround
Many states are passing legislation which allows for a SALT Cap workaround.
Background:
Taxpayers can deduct the larger of the Standard Deduction or their Itemized Deductions on their individual tax return. Itemized deductions include charitable contributions, mortgage interest expense, medical expenses over 7.5% of their Adjusted Gross Income (“AGI”) and State And Local Tax (“SALT”).
In the past, many taxpayer’s itemized deduction (including the SALT deduction) was greater than the standard deduction amount. In 2017, the Tax Cuts and Jobs Act (TCJA) limited the SALT deduction with a cap of $10,000 beginning in 2018.
Several states proposed a workaround for taxpayers with Pass-Through Entities (PTEs) such as partnerships, limited liability companies and S-corporations. In 2020, the IRS released Notice 2020-75 which approved the availability and functionality of such a workaround.
How it works:
The SALT Cap is a limitation at the individual level; there is no SALT Cap at the business entity level.
If you have a PTE business, the business prepays its share of state income tax before the end of the year. The computed state income tax is included as a business deduction on its federal income tax return (without limitation), reducing the net taxable income that passes through to your individual income tax return.
This tax payment is a Federal deduction only. It will be an add-back item on your individual state tax return.
To get the state tax deduction in the current year, the state tax payment needs to be made by year-end.
The PTE’s business state tax return will pass through a state tax credit to be included on your your individual state tax return.
The actual computed state income tax on your individual state tax return will be calculated including other income and /or deductions not used in the calculation at the PTE business level, so a resulting state income tax refund, or additional state income tax due, should be expected.
State Specific Notations: (updated periodically…)
Participating States:
15 states implemented legislation allowing for SALT Cap Workaround effective for 2021:
- Alabama
- California
- Connecticut
- Idaho
- Illinois
- Louisiana
- Maryland
- Massachusetts
- Minnesota
- New Jersey
- New York
- Oklahoma
- Rhode Island
- South Carolina
- Wisconsin
5 more states added similar laws beginning in 2022:
- Arizona
- Arkansas
- Colorado
- Georgia
- Oregon