- Guidance issued by the Internal Revenue Service and Treasury Department allows certain businesses to exceed a $10,000 cap on state and local deductions
- The move effectively gives federal blessings to state-level workarounds that have allowed businesses to be taxed at an entity level
- Businesses that pay corporate income tax are not affected
The Internal Revenue Service and Treasury Department have issued new guidance allowing certain businesses to exceed a $10,000 cap on state and local tax deductions, effectively blessing the strategies that several states have adopted to circumvent this restriction.
Under this guidance, partnerships and S corporations may deduct state and local taxes when determining their “non-separately stated taxable income or loss for the taxable year of payment,” thus ensuring that business owners who itemize their deductions are not subject to the cap. The guidance does not affect business owners who pay corporate income tax, since they can still deduct all of their state taxes; individuals are also still subject to the $10,000 limit.
The cap on state and local tax deductions, or SALT cap, was established in the 2017 Tax Cuts and Jobs Act. It was pushed by Republican lawmakers as a way to fund other parts of the bill and limit the federal subsidizing of states with higher state and local taxes. Democrats have sought unsuccessfully to repeal the SALT cap, saying it unfairly penalizes residents in blue states and limits their ability to provide public services.
Several states, primarily higher tax states like Connecticut but also some GOP strongholds like Louisiana and Oklahoma, adopted workarounds to allow businesses to avoid the SALT cap. The process allows business owners to pay state taxes at an entity level, rather than on their individual returns; this allows them to deduct the full state tax from their income, then receive a credit on their state tax returns to offset their individual tax liability.
Treasury Secretary Steven Mnuchin says the guidance will “provide fairness for America’s small businesses,” and “offer clarity for individual owners of pass-through entities.” It does not affect another state-level strategy, which effectively allows business owners to avoid the SALT cap by converting state and local taxes to charitable contributions; the Treasury has previously expressed its opposition to this workaround.
