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Is There a Workaround to the $10,000 SALT Deduction Cap?

State and Local Tax Deduction

When Congress passed the Tax Cuts and Jobs Act (TCJA) at the end of 2017, they placed a temporary cap on state and local tax (SALT) deductions. Beginning in 2018, taxpayers could only deduct up to $10,000 of state and local taxes on their federal returns. Being forced to forfeit even a portion of their deduction can be a tough pill for your clients to swallow. Is there anything you can do from a tax planning perspective to help your clients work around this limitation?

More About the SALT Limitation

Taxpayers who elect to itemize deductions on their federal income tax returns can take a deduction for the following state and local taxes:

  • Property taxes
  • Income taxes or sales taxes

Prior to the TCJA, there were no restrictions on SALT deductions, but beginning in 2018, taxpayers’ deductions were capped at $10,000.

Fortunately, this limitation is only temporary. Like other individual tax provisions in the TCJA, it expires at the end of 2025. This means that in 2026, the SALT deduction once again becomes unlimited.For taxpayers who have more than $10,000 of state and local taxes to report, waiting until 2026 isn’t an option. They want a fix to this problem now. Fortunately, many state governments have listened to taxpayers’ concerns and have come up with some unique solutions.

A Look at How Georgia and New Jersey Are Addressing the Problem

Georgia and New Jersey are just two of many states to come up with a workaround to the $10,000 SALT deduction limitation, and they do it in slightly different ways.

Georgia House Bill 149

Georgia House Bill 149 (H.B. 149), which was passed on May 4, 2021, introduced a new entity-level tax for Georgia S corporations and partnerships beginning in 2022. Instead of passing business income through to the individual owners, H.B. 149 allows business owners to elect to pay tax at the entity level. Electing businesses will tax their earnings at a flat rate of 5.75%, and individual owners can exclude business income from their personal state tax returns.

New Jersey BAIT

Alternative Income Tax (NJ BAIT) allows business owners of pass-through entities to elect to pay their tax at the entity level. The NJ BAIT takes the sum of each member’s share of distributive proceeds and taxes them using a progressive rate:

Individual owners must still report their share of business income on their state tax returns, but they can claim a refundable credit for the amount of NJ BAIT paid by the business.

In both iterations of this entity-level tax, individual SALT deductions are effectively converted to business SALT deductions, which face no limitations. The electing S corporation or partnership will do two things: (1) pay the state tax on business earnings, and (2) deduct those taxes, without limitation, from business earnings. This means that when business income is passed through to the individual owners and reported on their federal tax returns, that income will already be net of a SALT deduction.

What Are Other States Doing?

Georgia and New Jersey aren’t the only states creating a pass-through entity tax to circumvent the federal SALT limitation. New York, Oklahoma and almost a dozen other states have implemented similar laws, and it’s possible that more states will follow suit.

What Does the IRS Think?

The IRS has no problem with these workarounds. In fact, they plan to issue proposed regulations that confirm that these business-level SALT deductions are allowable.

However, the IRS isn’t on board with all remedies to the SALT deduction cap. In 2018, New York proposed a workaround to the SALT cap that the IRS ultimately disallowed. New York proposed the following: it would encourage individual taxpayers to donate to one of two separate charitable contribution funds — one for healthcare and one for education. When New Yorkers donated to these contribution funds, two things would happen: (1) they could deduct that contribution on their federal tax return, and (2) the state would give them a state tax credit of up to 85% of their contribution. This effectively transformed lost SALT deductions into charitable contributions, which face no federal limitations. The 85% state tax credit was to reward taxpayers for contributing to this fund.

The IRS stated that these types of workarounds were disallowed. Because taxpayers were given value in exchange for their donation, the donation was not deductible for federal income tax purposes. It was only after these workarounds were dismissed that states began to consider entity-level taxes as a solution.

Planning Considerations

If your client operates in a state that has enacted one of these SALT cap workarounds, here are a few things you should be thinking about:

What is your client’s state and local tax liability?

If your client doesn’t have a large SALT liability, the $10,000 SALT limitation may not affect them. The limitation tends to be an issue for taxpayers who are high earners and live in states that have high property or income tax rates.

Does your client itemize?

When the TCJA was passed, it raised the standard deduction. Today, fewer American taxpayers itemize than they did in 2017. If your client doesn’t itemize deductions, this SALT deduction cap won’t affect them.

What is the owner’s makeup of your client’s business?

Most states’ pass-through entity elections can only be made by entities that are 100% owned by individual taxpayers. If your client’s pass-through entity is owned by another entity — like another S corporation — they may not be able to make the election at all.

It’s possible, if not likely, that more states will pass SALT cap workarounds before the $10,000 cap expires in 2025, so pay close attention to news releases coming from your clients’ states. Once a new state law is passed, we will incorporate those changes into our tax planning software, which you can then use to calculate whether making the election will benefit your client.

If you want to see how our tax planning software works, request a demo today.

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