Maximizing Tax Benefits: Exploring SALT Cap Workarounds

September 5, 2023

Recently, the Wall Street Journal published an article entitled “The SALT Cap Has a $20 Billion Hole.” The premise of the article was that the projections of the additional revenue that would be received by limiting the SALT deduction to $10,000 under the Tax Cut and Jobs Act (TCJA) have not been fully realized due to creative maneuvering by tax professionals. This deduction limitation was designed to offset the costs of the reduced income tax rate implemented under the TCJA.

The TCJA and the SALT Deduction Limitation

Initially passed in 2017 by the Trump Administration, the TCJA went into effect on January 1, 2018, and will remain in force until December 31, 2025. The TCJA limited the ability of taxpayers to deduct state and local income tax, state and local sales tax, property, and other local taxes to a maximum of $10,000 (SALT deduction limitation). Prior to January 2018, taxpayers were only limited to their SALT deduction based on the Alternative Minimum Tax requirements. For individuals in states with a high income or property tax rate, the SALT deduction significantly impacted their federal income tax obligations. It is important to note that unless Congress passes a new law, the SALT deduction limitation will expire on December 31, 2025.

SALT Cap Workarounds

Many states have introduced SALT cap workarounds as a response to the SALT cap. Essentially, with the SALT cap workaround, entities like partnerships, S-Corps, or LLCs (taxed as partnerships), collectively referred to as “passthrough entities,” pay taxes at the entity level. These taxes are assessed at a fixed rate, such as the 3% rate used in Ohio as an example. The partners, shareholders, or members can then take a refundable credit against their applicable state income tax liabilities in proportion to their requisite entity interest or allocation structure (as outlined by the partnership agreement) or, if an S-Corp, in pro-rata to their share allocation. As a result of this workaround, the State still receives the necessary tax revenue, but the individual can reduce their federal tax obligation. It’s important to note that a single-member limited liability company would not qualify for this workaround unless it made an election to be treated as an S-Corporation.

IRS Support for SALT Cap Workarounds

While the Treasury Department has issued proposed or final regulations authorizing this maneuver, the Internal Revenue Service did issue IRS Notice 2020-75, in which they have blessed off on this workaround. Under IRS Notice 2020-75, a passthrough entity is allowed to take a deduction for the income tax payments that it makes to a State even if a partner or shareholder of that passthrough entity would receive a credit, deduction, or other tax benefit based on their applicable share of the income tax payment made at the entity level. In addition, the IRS clarified that the SALT deduction limitation does not apply to such payments.

Taking Advantage of SALT Cap Workarounds

Taxpayers living in one of the 36 states allowing the SALT cap workaround should consider implementing such an arrangement to reduce their individual tax liability. For additional support on how to implement a SALT Cap workaround, please get in touch with a member of KJK’s Tax Practice Group, including KJK’s Tax & Tax Exemption Practice Chair Demetrius Robinson (614.427.5749; DJR@kjk.com).