Huge news out of Treasury yesterday – the Department has blessed our SALT Parity reforms. You can read the full Notice here. As Law360 reports:
State and local taxes imposed at the entity level on pass-through entities are permitted as a deduction and this “is consistent with the longstanding position” of the U.S. Department of the Treasury and the Internal Revenue Service the agencies said Monday.
This announcement comes on the heels of the election results that have all but eliminated any remaining uncertainty about the value of our SALT Parity efforts. It is time for states to take action to help their employers. It also time for the accounting firms to get on board. Here’s what the Treasury Notice says:
The Treasury Department and the IRS intend to issue proposed regulations to provide certainty to individual owners of partnerships and S corporations in calculating their SALT deduction limitations. Based on the statutory and administrative authorities described in section 2 of this notice, the forthcoming proposed regulations will clarify that Specified Income Tax Payments… are deductible by partnerships and S corporations in computing their non-separately stated income or loss.
Seven states have adopted our reform to date (Connecticut, Wisconsin, Oklahoma, Louisiana, Rhode Island, New Jersey and Maryland) and another dozen are actively considering it as a legislative item for next year, so this announcement is both timely and helpful.
For those new to the issue, Tax Reform created an unlevel playing field for employers. As summarized by Richard Rubin in the WSJ:
The 2017 law that revamped the U.S. federal tax system imposed a $10,000 cap on the state and local tax deduction. That change pinched residents of high-tax states such as New York, New Jersey and Connecticut. Democrats have opposed the cap and tried to repeal it, but Republicans have refused.
The cap doesn’t apply to businesses that pay the corporate income tax, which can deduct all of their state taxes just as they did before the 2017 law.
But until Monday’s announcement, the cap did apply to many pass-through businesses, which make up the majority of U.S. firms. Those are organized as partnerships and S corporations whose taxes are paid on their owners’ individual tax returns.
So under the SALT cap, C corporations could fully deduct the state and local taxes they pay on their incomes, while most S corporations and partnerships could not. The policy blessed by the Treasury Notice restores balance by allowing S corporations and partnerships to restore their lost SALT deductions by electing to pay those taxes at the entity level, rather than at the shareholder or partnership level.
This change in the incidence of the tax results in a full deduction for the business. Shareholders and partners are protected from a double tax through an income exclusion or tax credit. The state taxes stay the same, but the businesses’ federal taxes are reduced by their full state and local tax payments.
Two states – Wisconsin and Connecticut – adopted this reform effective all the way back to 2018. For business in those states and others that already made the election and claimed the full SALT deduction, the Notice makes clear those savings are safe. It notes:
The proposed regulations described in this notice will apply to Specified Income Tax Payments made on or after [the date of publication]. The proposed regulations will also permit taxpayers… to apply the rules described in this notice to Specified Income Tax Payments made in a taxable year of the partnership or S corporation ending after December 31, 2017, and made before [INSERT DATE RELEASED BY MEDIA RELATIONS], provided that the Specified Income Tax Payment is made to satisfy the liability for income tax imposed on the partnership or S corporation pursuant to a law enacted prior to [date of publication]. Prior to the issuance of the proposed regulations, taxpayers may rely on the provisions of this notice with respect to Specified Income Tax Payments….
So states that acted early to adopt this reform will benefit fully, while those states looking to act next year can do so with the confidence that their businesses will benefit too. It’s a win-win, just like SALT Parity.