Cross-Via Entity Taxes: Mechanics, Concerns, And Planning Alternatives For Navigating SALT Cap Workarounds

The 2017 Tax Cuts & Jobs Act launched a $10,000 restrict on the State And Native Tax (SALT) deduction that was beforehand obtainable for taxpayers who itemized their deductions. In response to the brand new deduction restrict, many states enacted legal guidelines creating a brand new Cross-Via Entity Tax (PTET) designed to assist homeowners of pass-through companies (partnerships, LLCs, and S firms) keep away from the limitation and protect the deductibility of their state tax funds. With IRS giving its blessing to this strategy via Discover 2020-75, 33 states now have some type of PTET obtainable and, in consequence, homeowners of pass-through companies who dwell (or do enterprise) in these states could also be contemplating whether or not to make a PTET election.

At a excessive degree, PTETs work by permitting enterprise homeowners to elect to pay state taxes on their enterprise earnings – that are historically paid on their particular person tax returns – from the enterprise itself. This shifts the enterprise proprietor’s state tax funds from being a private expense (and topic to the $10,000 SALT deduction restrict for Federal tax functions) to being a enterprise expense that’s totally deductible from Federal earnings. Lastly, the enterprise proprietor will get a state tax credit score towards their particular person tax legal responsibility to partially or fully offset their share of the tax paid by the enterprise.

However whereas the easy description of PTETs would possibly make the choice to elect one seem to be a no brainer, in actuality there are myriad issues at play that imply an in depth evaluation is mostly required earlier than deciding to make an election or not. First, PTETs usually end in paying increased state taxes; whereas some states tax pass-through entities at a better charge than people, others could not present a 100% tax credit score for taxpayers to completely offset their share of the enterprise’s PTET paid (which means {that a} portion of that earnings is successfully double-taxed). Nevertheless, regardless that the PTET may end up in increased state taxes, the financial savings in Federal taxes that may end result from having the ability to deduct the PTET as a enterprise expense (together with not simply earnings tax however doubtlessly self-employment taxes, web funding earnings tax, and extra Medicare taxes as nicely) would possibly nonetheless make the election value it general.

One other set of issues includes homeowners of companies that function in a number of states, which might compound the complexity of electing a PTET. With a number of, usually conflicting state legal guidelines at play for enterprise homeowners, deciding whether or not or to not elect the PTET in any given state includes weighing not solely the impression of the state’s PTET on any potential Federal tax financial savings, but in addition further components concerned in electing a PTET throughout state strains. A few of these can embrace whether or not there are further submitting necessities (e.g., a enterprise proprietor who beforehand wasn’t required to file a nonresident return in a state the place they do enterprise could also be required to take action if the enterprise elects that state’s PTET) and whether or not the taxpayer’s dwelling state will give them credit score on their particular person tax return for entity-level taxes paid to a different state (which could end result within the enterprise earnings being taxed by 2 states without delay if the credit score isn’t allowed).

In the end, for a subset of taxpayers – particularly high-income homeowners of pass-through companies in high-tax states, who ideally solely do enterprise in 1 or a small variety of states to scale back the general complexity – PTETs can present a chance for vital Federal tax financial savings. Advisors who may help their purchasers with tax planning methods to benefit from PTETs – beginning with figuring out when it’s actually worthwhile to take action – can present vital worth given the complexity of the choice. And with the SALT deduction restrict presently set to run out after 2025, there’s no time like the current to begin delivering that worth!

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