The association composed of S-Corporation organization is asking: Why can C-Corporations deduct all their SALT while individual pass-through business owners are subject to a $10,000 cap on their SALT deductions? The IRS is still developing regulations that address the SALT workarounds some states have created for S-Corp parity on this matter. However, it appears the IRS will seek to restrict or invalidate such state actions attempting to level the playing field.
The S-Corp association reports that the following issues are in play regarding the IRS’s regulatory provisions:
- The current treatment of SALT deductibility for pass-through businesses is unpopular and a source of uncertainty for businesses and states alike.
- Treasury added "Guidance on applying the state and local deduction cap under §164(b)(6) to pass-through entities" to their priority list last November, suggesting that something is in the works.
- Treasury and the IRS would have to issue guidance on this topic regardless of state activity. The uncertainty surrounding the application of the SALT cap to pass-through business would require clarifying guidance either way.
- Whether this guidance might attempt to block companies from deducting their entity-level state taxes is entirely unclear, as is the legal basis for doing so.
Legal representatives for the state workaround efforts contend in a memorandum (see, memo) that:
State income taxes paid by S corporations and partnerships, limited liability companies and other entities treated as partnerships (collectively, "pass-through entities") under 2017 Wisconsin Act 368 ("Wisconsin Act 368") should not be subject to the new $10,000 state tax deduction limitation under section 164(b)(6) of the Internal Revenue Code of 1986, as amended (the "Code"). The Internal Revenue Service (the "Service") has consistently held that income and other taxes imposed upon and paid by pass-through entities are simply subtracted in calculating non-separately computed income at the entity level, and are not separately passed through or incorporated into the various provisions and calculations applicable to itemized deductions at the individual level, such as the standard deduction, alternative minimum tax and the Pease reduction. In discussing the final provisions of the Tax Cuts and Jobs Act, the Conference Committee Report explicitly reiterated and relied upon this principle in describing the scope of new section 164(b)(6) of the Code.
While the memo focuses on the new Wisconsin law, its analysis is relevant to other states as they move forward to restore SALT parity. Bills modeled after the Wisconsin effort have been introduced; these initiatives make states a more attractive place to invest and create jobs, all without reducing state revenue. The new legal analysis explains the authority behind these initiatives, and it's designed to help more states move forward and begin the process of restoring parity for S-Corp organizations.