New York Joins SALT Parity Effort

January 21st, 2021|

The good news on SALT Parity keeps rolling in. Just days after California’s Governor signaled his support, New York Governor Andrew Cuomo followed suit and included our pass-through SALT Parity language in his 2022 fiscal year budget proposal.

Since 2018, deductions on state and local taxes (SALT) paid by pass-through business owners have been capped at $10,000. C corporations, on the other hand, are allowed to fully deduct these same expenses. In those states that tax pass-through firms at the owner level, the disparate treatment puts them at a significant disadvantage compared to C corporations.

As S-Corp readers know, beginning in 2018 S-Corp and the Main Street Employers coalition have advocated for the restoration of the federal SALT deduction to pass-through businesses. States can restore parity by allowing pass-throughs an election to pay their SALT at the entity level. Shifting the incidence of the tax makes those payments deductible at the federal level, while maintaining revenue neutrality for the state. It is a win-win that was recently blessed by the Treasury Department, paving the way for states like New York to reduce taxes on their businesses at a difficult time.

New York initially raised this issue back in 2018. Its Department of Tax and Finance released a draft PTE tax plan that summer and S-Corp submitted comments recommending that the plan be constructed as an election, to protect some businesses from an unintended tax hike, and that S corporations be made eligible for the election alongside New York partnerships.

The briefing book accompanying Governor Cuomo’s budget proposal makes clear the state adopted our recommendations in their latest proposal. While several details need to be worked out, the basic structure of the proposal is promising:

“The Budget includes a new voluntary Pass-Through Entity Tax designed to mitigate the impact of the cap on state and local tax (SALT) deductions enacted in the 2017 Tax Cuts and Jobs Act. Pass-through entities can deduct this tax at the Federal level, thereby allowing partners of partnerships and shareholders of S corporations to receive the benefit of a full deduction for SALT paid before income is passed-through to them. A credit will be allowed against regular State income tax to offset the new Entity tax. This proposal aligns with similar efforts in Connecticut and enables individuals affected by the SALT cap to use IRS-allowed business deductibility to mitigate its impacts.”

In other SALT news, Treasury Secretary nominee Janet Yellen appeared before the Senate Finance Committee on Tuesday and was asked about the Biden Administration’s plans regarding the SALT deduction cap. She refused to commit to pursuing repeal and suggested instead that the incoming Biden administration would wait for a stronger economy before pushing for major changes to the tax code. Yellen stated:

“The SALT deduction was eliminated only a few years ago, and before making a decision about what should be done looking forward, I think it’s critical to study and evaluate what the impact has been on state and local governments on their ability to provide critical services, and I promise to work with those at Treasury and throughout the administration in evaluating what impact that has had on states and local governments…on households, on small businesses.”

With the White House and Congress under Democratic party control, many have speculated they would act quickly to repeal the SALT cap altogether. Yellen’s testimony suggests otherwise.

So, New York joins more than a dozen states actively considering our SALT Parity reform this year. With the uncertain prospects of federal action, the recent IRS blessing clarifying their position, and the effects of COVID continuing to negatively affect millions of businesses, this is the perfect time for states to take up this reform and help their Main Street businesses.

CA Governor’s Budget Includes SALT Parity

January 18th, 2021|

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.

Talking Taxes in a Truck (Episode 7) – George Callas on Tax Outlook, Effective Dates for Estate and Capital Gains Taxes, and Super Bowl Prediction

January 13th, 2021|

George Callas, Managing Director of Government Affairs and Public Policy at Steptoe, joins the podcast to discuss the tax outlook under President Biden and the new Democratic Congress, including upcoming stimulus debate, health care reforms, and the possibility of estate and capital gains tax hikes, and when those might be effective.

Our latest “Talking Taxes in a Truck” podcast was recorded on January 12, 2021, and runs 29 minutes.

Editor’s Note:  George would like to change his prediction that the Chiefs win the Super Bowl. He says it’ll be the Packers. 

You can access the podcast on Libsyn by clicking here. And, be sure to follow us on Spotify.

 

Don’t Sell Out Main Street

December 17th, 2020|

Congress is on the cusp of passing a truly bipartisan assistance package to help the families and employers through the last months (yeah vaccines!) of the COVID-19 pandemic.  As part of this package, the entire business community and its Hill allies support expanding and extending the Paycheck Protection Program (PPP) while clarifying congressional intent on the tax treatment of PPP loans.

As we’ve written before, getting the tax treatment of PPP loan forgiveness correct would avoid a surprise $120 billion tax hike on the five million employers who took out PPP loans.  Those employers were promised tax-free forgiveness when they applied for the loans, and that was what they understood when they spent the loan proceeds keeping their workers employed.

Tax-free treatment was consistent with the overall goal of the program – to give businesses the resources to keep workers employed during a time what their businesses were threatened by shut-downs and other responses to the pandemic.

That clear policy was turned on its head by an IRS notice that allowed PPP loan forgiveness to be tax-exempt, but disallowed the deduction of the wages and other expenses used to qualify for the forgiveness.  If an employer received a $100 PPP loan, spent all $100 on wages and other qualified expenses, asked for and received forgiveness for the $100, the IRS said he could continue to disregard the $100 as income, but he would be unable to deduct the $100 in related wages and expenses.  As others have pointed out, this ruling has the same effect as if Congress never included a provision to make the PPP loan forgiveness tax-free.

While the IRS ruling might be technically correct (it is certainly debatable), it is not what Congress intended nor what businesses were promised when they took out the loans.  Consistent with this concept of congressional intent, the Joint Committee on Taxation has scored legislation authored by Senator Cornyn (R-TX) to restore the correct tax treatment as having no effect on revenues.  As the JCT points out, those costs were already incurred as part of the CARES Act.

So the business community and bipartisan congressional leadership are united on a provision to avoid a $120 billion tax hike on employers during a pandemic, and the JCT has made clear that fix will add no cost.  What’s the hold-up?  Treasury.

Standing alone and in its final days, it refuses to acknowledge what Congress intended and continues to oppose the fix everyone else supports.  What is their rationale?  A recent piece published by Brookings is representative.  It argues that “Congress is on the verge of giving a $120 billion windfall to the top 1 percent in its pending COVID relief bill.”

If you’re a small business employer whose business has been ordered to be closed since last March by the governor of your state – literally ordered to close its doors under penalty of imprisonment – you might be surprised to know you’re getting a windfall.  You might be surprised by some of the other claims being made, too.  Here is a list of the more dubious arguments supporting the Treasury position, together with the response:

Myth:  “[P]assing legislation to allow businesses to pay their expenses with taxpayer-provided PPP funds and then to deduct those expenses against their own taxes would be a windfall to high-income business owners.”

Reality:  How do we know these employers have high incomes? Under COVID-19 many previously successful businesses are now losing money.  Hence the PPP.  Moreover, the amount of PPP loans is tied to payroll, not income.  The more employees a business has the larger the loan.  If the business uses the loan proceeds to pay those employees, then they can get those amounts forgiven.

Myth: “The PPP provided funds to certain business owners to pay employees and cover other expenses.”

Reality:  The PPP provided loans, not funds.  If the recipient spent the money paying their employees and covering other essential costs, then they might get those amounts forgiven.  The key here is the employers had to spend the loan proceeds on employees – even if those employees weren’t fully employed.  If they did, then the loan amounts equal to their expenditures would be forgiven.  Since the money had been spent keeping workers employed, the logic was that the loan forgiveness would be tax-free.

To emphasize this point, consider the alternative.  Congress would be asking employers to pay their employees and then pay taxes on the amount that they had paid their employees.  That makes no sense.  Such an approach would have encouraged employers forego PPP loans, lay off their employees, and owe nothing – no wages and no taxes.  That’s the situation Congress was trying to avoid.

Myth:  “But after passage of the CARES Act, business owners began lobbying for more: They wanted to deduct the expenses paid for by the PPP.”

Reality:  Brookings offers no evidence that employers are asking for more than what Congress promised, because it doesn’t exist.  The statutory language of the CARES Act makes clear that PPP loan forgiveness was supposed to be tax-free.  For the definitive statement, look no further than the Joint Committee on Taxation letter to Senator Cornyn, where the JCT made clear that PPP loan forgiveness was to be tax-free.

Myth:  “To summarize, business owners would benefit not only because the government paid for their labor and other expenses (which boosts the business owners’ take-home income), but again when they file their taxes.”

Reality:  Businesses were shut down.  They were told to close their doors and their customers were told to stay home.  Using PPP loans to keep workers employed under these circumstances is not a benefit to the employer, it is a benefit to the workers.

Myth: “To go through the math of how large that benefit is, the top rate on ordinary income today is 37 percent. But taxpayers today can carry back any unused deductions incurred this year to 2017, when the top rate on ordinary income was 39.6 percent (and 35 percent for corporations).

Reality:  Saying “unused deductions” is a euphemism for “you lost money this year” and “you’re broke.”  To qualify for carrybacks, employers would need to lose money in 2020.  If they lost money in 2020, they are probably not in the top 1 percent of income earners.  You can’t be both a top income earner and someone who benefits from loss carrybacks.

Myth:  “Business income and ownership is concentrated in the highest income groups—for the relevant group of pass-through business owners, about 70 percent of business income is earned by the top 1 percent of taxpayers. Hence, most of those deductions would be used by high income-taxpayers and save them $0.37 to $0.396 in taxes for each dollar they deduct.”

Reality:  70 percent of pass-through busines income might accrue to the top 1 percent but that is not the population of employers eligible for the PPP loans.  Those loans were limited to businesses 1) with 500 or fewer employers or 2) in certain hard-hit industries, like restaurants or hospitality.  That population excludes a large percentage of pass-through business income, as well as owners of private C corporations.  Brookings also continues to make the curious argument that business owners suffering losses are also high income.

Myth:  “In short, it’s a benefit targeted to the trifecta of inequity: (1) you need to own a business sophisticated enough to get a PPP loan; (2) the more income you have, the more you benefit; (3) your benefit is largest if you’re in the highest tax bracket.”

Reality #1:  Five million businesses got PPP loans – hardly a select crowd.  There’s no threshold of “sophistication” required.  Every business in the country was affected one way or another by COVID-19.  Every single one.  Many are subject to shut-down orders even today.  Most have survived so far.  Many hundreds of thousands (millions?), however, have not.

Reality #2:  The more income you have?  Wrong.  PPP loan size was determined by payroll, not income.  As many businesses experienced this year, you can have huge losses in 2020 even with hundreds of employees.  The PPP was designed to keep those jobs intact.

Reality #3:  The real PPP benefit is to survive the pandemic with your business and workforce intact.  That was the goal of the PPP.  To increase business survival and to maintain the workforce as much as possible.

The simple reality on PPP is that Treasury and Brookings are wrong.  Congress clearly intended for PPP loan forgiveness to be tax deductible.  Any change to that policy will result in a tax hike on the five million businesses that received PPP loans.  Such a policy not only fails the fairness test, it also fails the efficacy test.  Why provide $300 billion in new PPP funding if you’re just going to tax half of it away this April?  There is no good answer to that question, which is why Congress and the entire business community are united on this.  Its time for Congress to clarify the CARES Act and avoid this $120 billion tax hike on Main Street employers.

 

PPP Tax Treatment on the Line

December 15th, 2020|

With Congress poised to adopt a compromise COVID-19 package in the next week, a BIG outstanding issue is how loans forgiven under the Paycheck Protection Program (PPP) will be taxed.  It’s literally a $160 billion sword hanging over the head of Main Street.

On one side, you have key Congressional leaders and the entire business community in agreement that Congress wanted this money to be tax-free – more than 600 trades wrote to Congress just last week!  On the other hand, you have the IRS and the out-going Secretary of Treasury who calls it “double-dipping.”  Here’s the case for tax-free treatment:

It’s Not Double Dipping, It’s a Tax Increase:  The CARES Act created the PPP and made clear that any loan forgiveness would be tax-free.  That’s how the program was sold, that’s what borrowers were told when they took out the loans, that’s what they were told when they spent the loans, and that’s how the Joint Committee on Taxation (JCT) scored the original provision.  As the JCT wrote to Senator Cornyn:

Our staff understands (1) the exclusion in section 1106(i) of the CARES Act to be changing the baseline Federal income tax result, and thus (2) that the intent of that provision was not to deny deductions with respect to otherwise qualifying expenses. In other words, we understand the [Cornyn] proposal to be consistent with the original Congressional intent of section 1106(i) of the CARES Act.

Whether the IRS position is technically correct is beside the point – the IRS position isn’t what Congress intended.  Restoring congressional intent is a simple, technical fix that has no impact on Federal revenues, as those costs were already accounted for in the original CARES Act.

The Money’s Already Spent. Taking it Back is a Tax Increase:  The key to PPP loan forgiveness is the borrowers had to spend the loan proceeds on keeping workers employed.   Under the loan terms, if you spent the money on wages and other specified costs, then you could apply to have those amounts forgiven.  As noted above, those forgiven amounts were supposed to be tax-free.  If they aren’t tax-free, it will be a $160 billion hit to Main Street.  Where is the money going to come?  The loan proceeds have already been spent, and we’re still facing shut-downs related to the pandemic.

Undermines New COVID-19 Relief:  Making PPP forgiveness taxable would reduce the effectiveness of new PPP funding by half.  That’s because the tax hit would apply to both existing and new PPP loan amounts.  The five million first round borrowers will need to come up with $100-120 billion to pay the tax on those loans, while new PPP borrowers will need to set aside funds equal to about one-fifth of the new PPP loan amounts, or about $60 billion.  Add those up, and the surprise PPP tax hit will consume more than one-half of the new PPP funds authorized in the Bipartisan COVID-19 bill. It makes no sense for Congress to give Main Street relief with one hand, only to take half of it back with the other.

There is simply no justification for taxing loan forgiveness under the PPP.  It’s not what Congress intended and it will needlessly increase the pain being felt on Main Street at critical time.  Main Street businesses have already endured nine months of shut-downs and economic uncertainty.  Many of them operate in states, like California and New York, that are renewing their shut-down orders.  The new COVID-19 relief could help these businesses survive the winter surge and get to the other side, but its effectiveness will be cut in half unless Congress defends its prerogatives and insists that PPP loans remain tax free.  In the closing weeks of this Congress, it’s as simple as that.

View the Washington Wire Archives