SALT Cap Deduction Workaround for Business Owners Explained

SALT Cap Deduction Workaround for Business Owners Explained

If you’re a business owner trying to understand how the SALT cap deduction affects you, you’re not alone. This topic can be confusing, especially given recent changes that impact many taxpayers.

Let’s look at what’s actually happening with the SALT (State and Local Tax) deduction cap and how certain business owners might navigate it.

Understanding the SALT Cap

The SALT cap came into effect as part of the 2017 Tax Cuts and Jobs Act. Many high-earning individuals and those in states with significant taxes felt the impact most. This limit applies to those filing as individuals, heads of household, or married filing jointly.

Business owners who file as sole proprietors, or those operating through partnerships or S Corporations, might wonder if there’s any relief available.

The Pass-Through Entity Tax Workaround

Some states responded to the SALT cap by introducing a pass-through entity (PTE) tax. This workaround lets eligible businesses pay tax at the entity level. The business pays the state tax directly, often at the owner’s personal income tax rate. That payment is then taken as a deduction on the federal tax return of the business, avoiding the personal SALT cap.

This means, instead of the owner claiming state and local tax as a personal itemized deduction (and being subject to the cap), the business itself claims the deduction, which is not restricted by the SALT limit. The business owner typically receives a state tax credit for the amount the business paid.

Which Entities Qualify

The workaround applies to specific businesses. Entities such as partnerships and S Corporations are most commonly eligible. Sole proprietorships and single-member LLCs don’t qualify for the entity-level deduction because the IRS treats them as individuals for tax purposes.

The rules about which entities can participate vary by state, as does the process for electing into the PTE program.

States Participating in the Workaround

Not every state offers this solution. As of mid-2023, over 30 states had enacted PTE tax workarounds. Each has its own rules, deadlines, and forms. Some require an annual election. Others make it optional every year, while some require an initial irrevocable decision.

Reviewing current guidelines in your state is essential. These programs respond to the same federal rules, but the mechanics are state-specific.

What Happens for Federal Taxes

PTE tax payments are considered a deductible business expense for federal tax purposes. This can reduce the overall taxable income of the business before the owner’s share passes through to their personal return.

It’s important to know the deduction only applies to taxes paid at the entity level, not the owner’s personal state income tax payments.

Points for Business Owners to Understand

Business owners often look for ways to maximize their deductions. The PTE workaround is one method that may provide tax relief from the constraints of the SALT cap.

If you have a partnership or S Corporation, and your state offers a PTE election, consider whether this approach might align with your situation. Staying aware of your state’s requirements and deadlines is key.

While this workaround has helped many business owners, the landscape may continue to change based on federal and state tax policy developments.

Understanding Your Position

Many business owners feel overwhelmed by tax changes and limitations. The PTE workaround offers a potential path forward for relief from the SALT deduction cap, but it’s important to evaluate your specific circumstances and state rules.

Staying informed about available options can help bring some clarity and confidence as you navigate state and federal tax deductions.