Taxpayers and tax professionals alike have debated the merits and faults of The Tax Cuts and Jobs Act of 2017 (TCJA) over the last two years. One change that has negatively affected many individuals who itemize their federal deductions is the $10,000 limit on state and local taxes (SALT cap). Maryland recently joined Connecticut, New Jersey, and several other states employing a new strategy to provide a larger federal benefit to individuals for state taxes paid.
Background
Any taxpayer who paid state income or real estate taxes of more than $10,000 after 2017 does not receive a tax benefit nor is there a carryforward of the excess tax payments. This resulted in higher taxes for many taxpayers who itemized their deductions, especially those in New Jersey and other states with comparatively high state tax rates.
Change In Pass-Through Entity Tax Payments
On May 7, 2020, Maryland passed Senate Bill (SB 523). This law allows, but does not require, partnerships, S Corporations, and other pass-through entities (PTEs) to deduct the state taxes they pay for owners of the PTE in their calculation of taxable income. The PTE reports the amount of state taxes paid on behalf of the owner and when the owner files their personal tax return, the individual claims a tax credit for the amount of tax paid by the PTE. The law allows a PTE to lower the amount of income taxed to the PTE owners, but still requires PTEs to remit tax payments on behalf of nonresident owners.
Effective Date
SB 523 is effective for any business year beginning after December 31, 2019. The IRS has disallowed previous attempts by states to bypass the TCJA’s SALT cap but has not yet commented publicly about whether it will uphold this new strategy.
What Business Owners Should Do Now
SB 523 is designed to lower the income taxes of individuals whose federal deductions are limited by the SALT cap. PTE owners should work with their tax advisor to evaluate whether the SALT cap has limited their deductions and, if so, determine the impact on total taxes they would pay under this new alternative tax payment system compared to the current method.
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