The Tax Cut and Jobs Act (TCJA) of 2017 introduced significant changes to the U.S. tax landscape, including the imposition of the State and Local Tax (SALT) deduction cap. Under this cap, taxpayers are limited to deducting a maximum of $10,000 in combined state and local taxes on their federal income tax returns. For pass-through entities, such as partnerships, S corporations and sole proprietorships, this limitation can pose challenges. However, there are workarounds available that can help pass-through entities mitigate the impact of the SALT cap.
Understanding the SALT Cap
The SALT cap was introduced as part of the TCJA to limit the amount of state and local taxes that individuals and pass-through entities could deduct on their federal tax returns. This cap was implemented to help offset the revenue reductions resulting from other tax law changes. While it was intended to primarily affect high-income earners, it has implications for a broader range of taxpayers.
For pass-through entities, the SALT cap can be particularly problematic because they pass their income through to their owners, who then report it on their individual tax returns. As a result, the cap’s limitations can directly impact the owners’ ability to deduct state and local taxes paid by the business.
Workarounds for Pass-Through Entities
Pass- through entities have several options to mitigate the impact of the SALT cap. Here are some effective workarounds to consider:
Entity-Level Taxes: Some states have implemented entity-level taxes, allowing pass-through entities to pay taxes at the business level rather than passing the liability to individual owners. These entity-level taxes are not subject to the SALT cap, providing full deduction.
State Credits: Pass-through entities can explore state tax credits that may offset the SALT cap limitations. Some states offer credits for taxes paid at the entity level, effectively reducing the owners’ federal tax liability.
Electing S Corporation Status: S corporations are subject to a different set of tax rules compared to partnerships and sole proprietorships. S corporation shareholders can potentially reduce their taxable income by taking advantage of lower salaries and higher distributions, which may help offset the impact of SALT cap.
Consideration of Other Deductions: Owners of pass-through entities should explore other available deductions, such as the qualified business income deduction (Section 199A deduction), which may help reduce their overall taxable income.
Location Strategy: In some cases, changing the location of a pass-through entity’s operations or its state of incorporation may offer tax benefits that offset the SALT cap limitations. However, this strategy requires careful consideration and planning.
State and Local Tax Planning: Implementing effective state and local tax planning strategies can help reduce the overall tax liability of pass-through entities. This may involve structuring transactions to minimize state and local tax obligations.
Consultation with Tax Professionals: Given the complexity of tax laws and regulations, it’s essential for pass-through entities to work closely with experienced tax professionals who can assess their specific circumstances and provide tailored solutions.
While these workarounds can be effective in mitigating the impact of the SALT cap, it’s crucial for pass-through entities to carefully consider their individual situations and consult with tax professionals to ensure compliance with federal and state laws. Additionally, state tax laws and regulations can vary significantly, so a one-size-fits-all approach may not be appropriate. As tax laws continue to evolve, staying informed and adaptable is essential to ensure compliance and maximize tax efficiency for pass-through entities and their owners. Contact Better Accounting today to make sure you optimize your tax strategies and minimize the impact of the SALT cap
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