The SALT Cap and State Taxation of Pass-Through Entities

Among the many significant changes in the 2017 Tax Cut and Jobs Act (TCJA), individual taxpayers’ deductions for state and local taxes (SALT deductions) on federal Form 1040 Schedule A were capped at $10,000 ($5,000 for married taxpayers filing separately).  The “SALT cap” results in reduced itemized tax deductions for individual taxpayers, particularly impacting homeowners paying property taxes on their residences and wage and income earners subject to state and local income taxes.

Of course, the expanded “standard deduction” benefitted many taxpayers, but possibly did not produce enough of a net benefit, particularly for taxpayers residing or working in high tax states.

In the aftermath of TCJA, several states immediately began looking at ways that would provide a workaround to avoid the federal return SALT cap limitation.

To date, over a dozen states have changed their tax laws to replace the state income taxation of individuals on their business income (subject to the SALT cap) with a corresponding income tax imposed on pass-through business entities (i.e., partnerships, limited liability companies taxed as partnerships and S corporations), which tax is paid and deducted at the entity level and therefore not subject to the SALT cap.

The Internal Revenue Service effectively sanctioned the workaround, for appropriately designed pass-through entity (PTE) taxes, in IRS Notice 2020-75.

As always, tax laws vary in each state following their specific statutes. Relevant provisions include:

  • Whether the PTE tax in a state is elective (most states) or mandatory (e.g., Connecticut);
  • When the election is made (and whether it may be revoked); and
  • Whether or when estimated PTE taxes must be paid, among other issues.

Most importantly, taxpayers must carefully determine whether the federal after-tax benefit outweighs the specific state PTE tax (a PTE tax might be imposed at the highest income tax marginal rate or deny a partner’s or S shareholder owner’s unreimbursed business expenses).

Finally, most states provide that their PTE tax is not available when the federal SALT cap sunsets under the TCJA in 2025 or if the federal tax laws are changed before 2026, which may increasingly become a possibility, further complicating business owners’ tax planning and compliance.

For more information, please contact Tom Hammerschmidt in the firm’s Ann Arbor office at 734-623-1602, or any of the firm’s tax specialists located in our Dickinson Wright U.S. offices.

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About the Author:

Tom Hammerschmidt is a Member with Dickinson Wright’s Tax Group. He can be reached at 734-623-1602 or, and his biography can be accessed here.