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IRS provides certainty on SALT deductions by certain businesses

Posted by Admin Posted on Nov 13 2020

Dear Client:

The passage of the Tax Cuts and Jobs Act on December 22, 2017 limited an individual’s deduction for State and Local taxes (SALT deduction limitation) to $10,000 ($5,000 in the case of married individual filing separately).  This includes real property taxes, personal property taxes, and state income taxes.  The impact of the limitation began with the 2018 tax year.  Many individuals exceed the $10,000 limitation and have lost tax deductions on the 2018 and 2019 federal tax returns. 

Several states such as Connecticut, Louisiana, Maryland, New Jersey, Oklahoma, Rhode Island, and Wisconsin have adopted as a “workaround” an entity level tax for partnerships and S corporations.  Effective July 1, 2020, Maryland partnerships and S corporations may elect to pay tax on behalf of individual resident members at the top marginal state tax rate of 5.75% plus the lowest local income tax rate of 2.25% of the members share of income.  

On November 9, 2020, the IRS announced in Notice 2020-75 that the Department of Treasury and IRS intend to issue proposed regulations to clarify that SALT taxes imposed on and paid by a partnership or an S corporation on its income are allowed as a deduction by the partnership or S corporation in computing it’s taxable income and therefore, the payments would not be subject to the SALT tax deduction for the member. 

As an example:  Sue is a member of Sunrise Partnership.  Sue pays real estate taxes of $10,000.  In addition, Sue normally pays estimated Maryland income taxes of $30,000 (assume 8% state tax rate) from her share of income from Sunrise Partnership.   Sue’s SALT deduction is limited to $10,000 and the $30,000 would be considered lost tax deductions on her federal tax return.  Effective July 1, 2020, the Sunrise Partnership can make an election to pay the $30,000 of Sue’s Maryland state income taxes at the Partnership level.  Sunrise will be allowed a tax deduction for the full $30,000 which would effectively reduce Sue’s federal taxable income from the Partnership.  According to IRS Notice 2020-75 announced on November 9, 2020, the $30,000 paid by the Partnership will not be subject to the $10,000 SALT limit on Sue’s personal tax return.  When Sue files her Maryland individual tax return, she would add back the $30,000 to income as previously required by Maryland law.   

We consider this a major development for business owners of partnerships and S corporations.  There are some unanswered questions that need clarification and we intend to keep you informed on these developments.  This will impact upcoming estimated tax payments for the 4th quarter as the partnership or s corporation must make the payments before December 31, 2020.  

Please let us know if you have any questions how this may impact your business and your personal tax liabilities.  Stay tuned for more information from us on this matter. 

All the best, 

James