On November 9, the IRS released Notice 2020-75 announcing its plan to issue proposed regulations that many have been waiting for. The regulations will confirm that entity-level state and local taxes (SALT) imposed on pass-through entities are not subject to the $10,000 SALT deduction limit.
Below, we answer common questions about the notice and what it means for business and individuals.
What is the SALT deduction limit?
The Tax Cuts and Jobs Act (TCJA) limited the amount an individual can deduct from the amount of the following state and local taxes they paid during the calendar year: 1) real property taxes, 2) personal property taxes, 3) income, war profits and excess profits taxes and 4) general sales taxes. The deduction limit is $10,000. Note that the limitation does not apply to any taxes that are paid or incurred in carrying on a trade or business or an activity described in IRC Section 212.
In response to the TCJA-added SALT deduction limit, several states (Connecticut, Wisconsin, Maryland, New Jersey, Oklahoma, Louisiana and Rhode Island) passed laws that allow state and local income taxes to be paid at the entity level rather than at the individual level.
Why is the IRS releasing these regulations?
In the Notice, the IRS recognized that there is some uncertainty as to whether entity-level payments made under state and local laws that impose entity-level income tax on partnerships and S corporations must be taken into account when applying the SALT deduction limitation at the owner level.
The proposed regulations from the IRS will clarify that “specified income tax payments” are deductible by partnerships and S corporations in computing their non-separately stated income or loss.
What are specified income tax payments?
A specified income tax payment refers to any amount paid by a partnership or an S corporation to a domestic jurisdiction (which is defined as a state, a political subdivision of a state or the District of Columbia) to satisfy its liability for income taxes imposed by the domestic jurisdiction. This definition does not include income taxes imposed by U.S. territories or their political subdivisions.
Under the proposed regulations, any specified income tax payment will not be treated as a separately stated item and will not be taken into account when applying the SALT deduction limitation to any individual who is a partner in the partnership or a shareholder of the S corporation.
What time period would the proposed regulations apply to?
The proposed regulations will apply to specified income tax payments made on or after November 9, 2020, but they will also permit taxpayers to apply the rules to specified income tax payments made in a tax year of the partnership or S corporation ending after December 31, 2017, and before November 9, 2020 — provided that the specified income tax payment is made to satisfy the liability for income tax imposed on the partnership or S corporation pursuant to a law enacted prior to November 9, 2020.
Considerations in making an election to pay state taxes at the entity level
There are a number of items to be considered — such as income tax rate applied, treatment of capital gains and whether nonresident partners or shareholders still get a credit for taxes paid to others states — in deciding whether it’s cost beneficial to make an election to pay state taxes at the entity level.
How can Wipfli help?
Our tax professionals can help you understand what your tax obligations are and what you can and cannot deduct under the SALT deduction limit. If you have questions about these proposed regulations or your unique situation, please contact us.
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