More good news on the pass-through SALT Parity front: California Gavin Newsom has included our SALT Parity proposal in his budget proposal for 2021.
This news comes on the heels of IRS Notice 2020-75 that confirmed our efforts and made clear to states and businesses that they could adopt SALT Parity legislation without worrying about future regulatory actions.
Seven states have adopted our reform to date (Connecticut, Wisconsin, Oklahoma, Louisiana, Rhode Island, New Jersey, and Maryland). Helped by this announcement, we expect that more than a dozen states will join California in taking up SALT Parity legislation this year. It is a great way to help Main Street employers during the COVID-19 pandemic without reducing state revenues.
Increased interest means increased questions about how it works and why it is the right plan to help Main Street employers during a very difficult time. Below is a Q&A based on questions we fielded in recent weeks.
Q. Where is the “parity” in SALT Parity?
A. Tax reform capped deductions for state and local income taxes at $10,000 per year. This cap applied to the business income of pass-through businesses, but not the income earned by C corporations. C corporations may continue to fully deduct the SALT they pay as a business expense against federal taxes. As most states impose tax on pass-through businesses at the owner level, the disparate treatment puts them at a significant disadvantage compared to C corporations.
Q. What does the California SALT parity proposal do?
A. It’s taken from our model SALT parity legislation, first adopted in Connecticut and Wisconsin, which permits pass-throughs to restore the value of their lost federal 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 income tax payments.
Q: What did the IRS Notice say?
A: IRS Notice 2020-75 announced their intention to propose regulations clarifying that state and local income taxes paid by a partnership or S corporation are allowable as deductions against the business’ income for federal tax purposes. The Notice also makes clear those deductions are allowed when they are the result of an election or if the business owners receive tax credits or income exclusions equal to the taxes paid by the entity. Finally, taxpayers were told they can rely on the Notice when filing their taxes this year, and that this interpretation applies to tax years preceding the Notice’s publication. In other words, our pass-through SALT Parity policy works.
Q: Will the IRS change its position?
A: Highly unlikely. Notice 2020-75 is based on the agency’s reading of the relevant statutes and precedents, and those haven’t changed. Moreover, the incoming Administration is on record opposing the underlying SALT deduction cap. If anything, it is likely to speed the release of the proposed rules.
Q: How does SALT Parity work?
A: The SALT deduction cap applies to individual tax payments, not business tax payments. So SALT paid by an individual is subject to the $10,000 cap while SALT paid by a C corporation is not. S corporations and partnerships are stuck in the middle – the SALT paid by their owners is subject to the cap but the SALT paid directly by the business is not. Our SALT Parity plan shifts the incidence of the state tax from owners to the business. The business pay the tax and then deduct the payment as a business expense. As a result, the income flowing through to the owners is reduced on their federal taxes.
Q: Will Congress or the Biden Administration repeal the SALT caps?
A: It’s unlikely actions by the new Congress and Biden Administration completely eliminate the benefits of SALT Parity. On the other hand, it is likely Congress will consider policies that would increase the value of SALT Parity. Related to the SALT cap, Congress could:
1. Repeal the SALT caps entirely;
2. Increase the SALT caps;
3. Cap the tax benefit of itemized deductions; and/or
4. Restore the Pease limitation on itemized deductions.
Only Option 1, adopted without options 3 or 4, would completely eliminate the benefits of SALT Parity. On the other hand, any combination of options 2-4 would leave all or some of the SALT Parity benefits intact.
Q. How is SALT Parity “revenue neutral” for states but still a tax cut?
A. SALT Parity restores the full federal SALT deduction for pass-through businesses. It does so by shifting the incidence of the SALT from the owner(s) to the business itself, thereby making those payments deductible at the federal level. As noted above, the SALT cap applies to taxes paid by individuals and families only, not taxes paid by businesses. SALT Parity is designed to be revenue neutral to the state by charging the business entity a tax equal to the tax paid by the business’ owners. Depending on how their tax code is structured, some states might see a small increase in their revenues. Owners of electing businesses are protected from double taxation through a tax credit or income exclusion equal to the pro-rata portion of the income or tax paid by the business entity. States get their revenues, and Main Street businesses benefit.
Q. Should my state enact SALT Parity?
A. SALT Parity works in states where taxes on pass-through business income are paid by the owners, not the business. SALT is already fully deductible in states, like Tennessee, that already tax pass-through business income at the entity level. Meanwhile, states with no individual income tax, like Texas and Florida, are unaffected by the new SALT cap. Most states, however, do tax pass-through income at the owner level and would benefit from this reform. S-Corp estimates there are 41 states that would benefit from our efforts. Of those, seven have already adopted SALT Parity legislation (Connecticut, Wisconsin, Oklahoma, Louisiana, Rhode Island, New Jersey and Maryland) while more than a dozen others, including New York and California, are actively considering it in 2021.
Q. Does SALT Parity increase complexity?
A. SALT Parity is simple – it is the underlying state tax income codes that are complicated. SALT Parity would replace multiple tax returns and payments with a single, uniform return and payment. How those dollars are apportioned among states and entities within a state can get complicated, but it already is complicated. An entire industry of accountants and tax attorneys exists to address the complexities of state and local tax policy. SALT Parity does not add to this complexity.
Q. Does SALT Parity benefit all pass-through businesses?
A. No. Depending on their facts and circumstances, including where their owners reside, SALT Parity might not work for all businesses. That is why it is critical that SALT Parity allows each business to elect whether to pay their SALT at the entity level. Those businesses that would benefit can make the election, while the other businesses continue to continue to pay their SALT at the owner level, just as they always have.
Q. What businesses benefit from SALT Parity?
A. S corporations, partnerships, and LLCs benefit from SALT Parity. Sole proprietorships and single member LLCs do not. For SALT Parity to work, there must be a legal entity – a corporation or partnership – to pay the taxes. Sole proprietorships are not separate legal entities, while single member LLCs are generally disregarded for tax purposes.