A growing number of states are offering intermediate business owners a workaround for the federal deduction limit of $ 10,000 for state and local taxes, known as SALT.
A controversial part of the Republicans’ 2017 tax review, the SALT write-off cap is costly for filers who itemize deductions and can’t claim more than $ 10,000 for property and state income taxes.
The limit has been a burden for those in high tax states, such as California, New Jersey and New York. Although there has been pressure to repeal the law, President Joe Biden has not included the measure in his proposals.
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While the IRS and the Treasury have blocked some individual strategies to get around the cap, some states have created a workaround for middle-tier businesses, such as partnerships, S corporations, and some limited liability companies.
The IRS issued guidance on these state-level tactics in November 2020, giving some companies the green light.
More than a dozen states have passed legislation to approve the workaround, including Alabama, Arkansas, Arizona, California, Colorado, Connecticut, Georgia, Idaho, Louisiana , Maryland, Minnesota, New Jersey, New York, Oklahoma, Rhode Island, South Carolina and Wisconsin, according to the American CPA Institute.
There is pending legislation in Illinois, Massachusetts, Michigan, North Carolina, Oregon and Pennsylvania, the AICPA said.
While the maneuver may offer tax savings for some business owners, it may not be the right decision in all cases, according to financial experts.
“The devil is in the details,” said certified financial planner Sharif Muhammad, founder and CEO of Unlimited Financial Services in Somerset, New Jersey.
How the business pass-through tax works
Most American businesses are intermediary businesses with the profits going into the owners’ individual tax returns.
The new bypass typically involves a state tax on these businesses, allowing the business to cover part of the owner’s state income taxes.
The transfer company usually pays the tax. But while some states allow an entity-level deduction, others offer a credit for taxes paid.
For example, last week, Governor Gavin Newsom of California signed a law allowing certain companies to pay an additional 9.3% levy on each owner’s share of the company’s net income.
Homeowners who participate can then claim a credit on their California tax return equal to the 9.3% tax.
“You have effectively prepaid your state taxes on your transferred income,” said Perry Ghilarducci, CPA and partner at Avaunt Ltd. CPAs & Consultants in Sacramento, California.
Not suitable for all businesses
The workarounds may seem like a welcome relief for business owners who shell out tens of thousands of dollars in property taxes and state income taxes each year.
However, it is essential to calculate the numbers before doing anything, Muhammad said.
A business owner needs to review his taxes at the entity level and at the personal level, he said. For example, if they do not itemize the deductions, the benefits may not be as great.
Plus, a business owner in a lower tax bracket may overpay their public deductions for the year, Ghilarducci said.
“The numbers have to be presented, and everyone has a different situation,” Muhammad added.