One of the most hated tax provisions for people in higher-tax states is the so-called SALT limitation on state and local taxes.
What is the SALT Limitation?
The provision was part of the Tax Cuts and Jobs Act, which only allows taxpayers who itemize their deductions to deduct a maximum of $10,000 on their federally taxed income for local property, sales, and income taxes paid to state and local governments. The limitation is especially punitive to joint tax filers because the $10,000 limit is the same for single and joint tax returns.
If spouses file separately, each can only deduct $5,000 each of these local tax obligations.
Creative SALT Workarounds
Several states have proposed creative workarounds for this limitation. One possibly includes allowing state tax obligations to be paid as a charitable contribution, which would make them more likely to be deductible. The IRS publicly frowned on the charitable workaround. So, some states—Louisiana, Oklahoma, Rhode Island, Wisconsin, New Jersey, Maryland, and Connecticut—managed to find a different structure—and surprisingly, it looks like the IRS is going to go along.
The workaround only works for individual owners of pass-through businesses like a partnership or S corporation. The idea is that the company—not the individual taxpayer—could pay the SALT taxes. Then, they can take a deduction for these expenditures at the business level. The value of the deduction would pass through to the individual business owners.
The Future of SALT Workarounds
Would that be legal? On November 9, the IRS released Notice 2020-75, which agreed that pass-through businesses could claim deductions at the business level for state and local income tax paid. There were state laws that would shift the tax burden from individual owners to the business entity. You can look for more states to follow the lead of the pioneering jurisdictions and for taxpayers to set up side businesses as a way to get all or part of this valuable deduction.
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