Pass Through Entity Level Tax Elections

The Tax Cuts and Jobs Act of 2017 (TCJA) made many changes to the way business and individual taxes are calculated at the Federal (IRS) level. TCJA changed income tax rates, deductible expenses, deduction limitations, tax credit calculations and many other items. One notable change is the limit on the state and local tax (SALT) deduction for individual taxpayers who itemize. Prior to TCJA, the SALT deduction was only limited by the total itemized deduction limitations. However, the TCJA put a $10,000 cap on the SALT deduction.

The SALT deduction typically includes state and local income taxes and real estate taxes. So, a significant number of taxpayers are impacted by this cap. The states and the IRS have battled back and forth for a number of years to find ways to get around this cap. One approach that found footing is the election for a business filing as a pass-through entity (i.e. a Partnership or S-Corporation) to pay taxes on state income at the entity (business) level. This allows for an uncapped Federal SALT deduction at the entity level for the state taxes paid at the entity level. The Federal net income from the pass-through entity, reduced by the SALT deduction, is then passed through to the individual. Please note this election only benefits individual taxpayers whose SALT deduction includes state income tax that is generated from a pass-through entity.

Many states have since implemented this election. Locally, both Maryland and Virginia have adopted this approach. DC has already had an entity level tax for many years. It is important to remember that since each state has a different governing body and tax authority, there will be many approaches to this election and possibly additional adjustments required at the state level. It is for this reason that we strongly suggest you consult a tax professional to assist with these matters.