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To Qualify, Single Member LLCs and sole-proprietorship would have to become S-corporations or Partnerships for Tax Filing Purposes.

  • Since the Tax Cut and Jobs Act was passed, there’s been a $10,000 cap on the state and local/property tax deduction on individual federal income tax returns.
  • However, California now offers workarounds, allowing some pass-through business owners to sidestep the limit on state income and property tax write-offs.

A growing number of states, including California, are offering pass-through businesses (S-corporations, LLC that file a partnership tax return, and partnerships) a workaround for the $10,000 federal deduction limit for state income and property taxes, known as SALT (state and local taxes).  

Note, however, single-owner LLCs and sole proprietorships do not qualify for this tax break.

A controversial part of Republicans’ 2017 tax overhaul (“The ax Cut and Jobs Act),  the SALT write-off cap was and remains very costly for filers who itemize deductions and can’t claim more than $10,000 for property and state income taxes. 

The limit has been a burden to those in high-tax states, such as California.

The IRS has issued official guidance on these new state laws as in November 2020, offering the green light to certain businesses.

More than a dozen states have passed legislation to approve the workaround, including Alabama, Arkansas, Arizona, California, Colorado, Connecticut, Georgia, Idaho, Louisiana, Maryland, Minnesota, New Jersey, New York, Oklahoma, Rhode Island, South Carolina and Wisconsin, according to the American Institute of CPAs. There is pending legislation in Illinois, Massachusetts, Michigan, North Carolina, Oregon and Pennsylvania.

However, it may not be the right move in all cases, financial experts say. 

How the tax on pass-through businesses works

Many companies are pass-through businesses with profits flowing to owners’ individual tax returns.

The new law allows the state income tax that would normally be paid by the owner, to be paid by the business entity.  If paid by the business entity, its federal taxable income passed-through to the owner will be lower by the amount of the state tax so paid, effectively giving the business owner a reduction in federal taxable income for the state income tax paid by the business, which is otherwise not available as a tax deduction for high-income individual taxpayers.

California Senate Bill 150 allows these qualifying businesses to pay an extra 9.3% tax on each owner’s share of the company’s net income.  Owners who participate may then claim a credit on their California tax return equal to the 9.3% tax, so that they only pay tax once company pass-through income.

By: John Balian, J.D. MS Tax, Of Counsel to Schneiders & Associates, L.L.P.

Adapted from CNBC Article published July 22, 2021

Source: https://www.cnbc.com/2021/07/22/some-states-offer-workarounds-for-state-and-local-tax-deduction-limit.html

About the Author
Theodore J. Schneider practices in the areas of business and corporate transactions, employment law counseling, municipal and public law, real estate and land use, and homeowner associations. Ted began his legal career in 2002 when he joined the Los Angeles office of Gibson, Dunn & Crutcher, L.L.P. before relocating to Ventura County to join his father in practice.