The Tax Cuts and Jobs Act enacted in late 2017 placed a $10,000 per year limit on individuals’ deduction for state and local taxes (SALT) on Schedule A as itemized deductions. Many states with an individual income tax immediately began looking for workaround solutions to enable their residents to continue to receive a Federal income tax benefit for the state income tax paid.
To date, at least 20 states (including Georgia) have enacted or introduced legislation permitting S-corps and partnerships to elect (except in Connecticut where it is mandatory) an entity level tax in lieu of the income being taxed at the level of the individual owners. In Notice 2020-75, the IRS indicated that such a tax would be deductible by the entity as a business expense; effectively permitting a workaround to the $10,000 SALT deduction limitation at the individual level.
The rules vary from state to state, but are generally somewhat similar to those enacted by Georgia. Effective for 2022, Georgia permits an eligible pass-through entity (an S-corp or a partnership 100% owned and controlled by persons who would be eligible to be S-corp shareholders) to elect (on timely filed return) to incur entity level tax in lieu of income flowing through to the owners. This is an annual election and, if made, the owners exclude from their Georgia taxable income the income which was subject to the entity level tax. If an entity intends to make the election, it should make quarterly estimated tax payments. Estimated payments made by the owners cannot be transferred to the entity. However, the entity can avoid incurring a penalty for underpayment of estimated tax by showing that the owners instead made personal estimated payments.
Under the rules of some states, rather than excluding from owner taxable income the income which was subject to entity level tax, the owner claims a credit on his or her personal tax return for their share of the tax paid at the entity level.
While it might seem a no-brainer to make the entity level tax election and gain the benefit of Federal deduction, it is actually a complicated decision. You have to consider whether the individual owner(s) have tax attributes or credits at their personal level that will go unutilized if you make the election, and how the state(s) of residence of the owner(s) will treat the K-1 income. This gets particularly complicated if you have a flow-through entity which is operating in multiple states and has owners who are resident in multiple different states.
Proposed legislation would increase the SALT deduction limit to $80,000, and some in Congress would like to repeal the limitation altogether. If this happens, then these entity level tax SALT workarounds may become unnecessary (although they could still be beneficial if the entity has owners for whom the benefit of a deduction for state income tax is limited by the alternative minimum tax). Finally, we note that even in the absence of Congressional action, the $10,000 cap on deduction of SALT is scheduled to expire at the end of 2025.
Kenneth H. Bridges, CPA, PFS and Jacquelyn B. Gibson, CPA are with Bridges & Dunn-Rankin, LLP, an Atlanta-based CPA firm.
This article is presented for educational and informational purposes only, and is not intended to constitute legal, tax or accounting advice. The article provides only a very general summary of complex rules. For advice on how these rules may apply to your specific situation, contact a professional tax advisor.