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New Workaround in Effect to Bypass Sales and Local Tax (“SALT”) Deduction Cap

California law has changed to allow a workaround of the $10,000 SALT deduction cap for business owners.

The Notorious SALT Deduction Cap

Since the ratification of the federal income tax via the Sixteenth Amendment, federal law has allowed taxpayers to deduct their taxes paid to states in the form of property taxes, income taxes, and sales taxes.

This tax deduction has become casually known as the SALT deduction and has substantially benefited taxpayers in high-tax states like California.

The Tax Cuts and Jobs of Act of 2017 put a $10,000 cap on the SALT deduction for years 2018 through 2025.

What is Pass-Through Entity Tax?

In 2021, California (along with numerous other states) enacted an elective “Pass-through Entity Tax” (PTE). The law works around the $10,000 SALT deduction cap.

Generally, pass-through entities (LLCs, Partnerships, and S-Corporations) are not subject to their own income tax. Entity owners report the entity’s income and pay the entity’s taxes directly as individuals. Thus, state income taxes paid on behalf of the entity are subject to the individual taxpayer’s SALT deduction cap.

However, with the PTE tax election made, an entity will voluntarily elect to pay an entity-level income tax on its qualified net income to California and take a deduction on these taxes paid at the federal level. The deduction is “above the line” and not subject to the $10,000 deduction limitation. Qualified taxpayers are eligible to claim a nonrefundable credit for taxes paid on the entity’s qualified net income.

How can YOU benefit from the Pass-Through Entity Tax election?

For those who own real estate investments or other business investments, it is important to formally organize your business to qualify for the PTE election.

If your business is taxed as a disregarded entity, it will not qualify for the PTE election; the entity must be taxed as a partnership or S-corporation.

Please contact us if you have any questions on this beneficial law and the potential opportunities for your business.