IRS Blesses Workaround for dodging the cap on state & local tax deduction - Spidell

IRS Blesses Workaround for dodging the cap on state & local tax deduction

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Message Board IRS Blesses Workaround for dodging the cap on state & local tax deduction

  • This topic has 4 replies, 3 voices, and was last updated 2 weeks ago by Mark Bole.
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    • #279878
      Hani Sharestan
      Participant

      Good afternoon. Our firm recently became aware of potential to deduct state taxes in relation to a taxpayer’s flow-through income without hitting the federal $10,000 CAP state taxes paid itemized deductions. Here’s a link:

      https://www.cnbc.com/2020/11/18/thisthe-irs-is-blessing-workaround-that-allows-business-owners-to-deduct-state-and-local-taxes.html

      What is Spidell’s opinion on this? Is there an indication that California might embrace this and allow taxes to be paid at the LLC or S-corporation level? Any input is appreciated. Thank you.

    • #279887
      Jamie Mechulan Castiel
      Participant

      I assume that this does not apply to personal residences or second homes

      ie can you pay your $20,000 residence, or second home, real estate tax through your business pass through entity

      and deduct the entire amount?

       

    • #279888
      Hani Sharestan
      Participant

      I doubt this would work for property taxes. The article talks only about state taxes on flow-through income. The business has no responsibility to pay personal expenses. The article I’m sharing above relates to taxes paid on business income resulting from a K-1. My question is will California allow these state income taxes to be paid and deducted at the LLC or S-corp level?

    • #279903
      Mark Bole
      Participant

      There is another current post on this topic.

      It has nothing to do with businesses paying personal income or property taxes.  That is not allowed, obviously.

      What it means is that IF a given state passes a certain kind of tax law (which CA has not yet done), they can impose a mandatory or voluntary BUSINESS state tax on the pass-through entity.  The business pays it and can deduct it in full on the federal return (because it is a BUSINESS, not a personal income tax).  Just like CA businesses now typically deduct the $800 annual franchise tax on their federal returns.

      So what good does that do?  Well, to be worthwhile, the state law (which CA has not implemented) would also give the owners of the business a CREDIT or DEDUCTION on their PERSONAL income tax return for the state tax paid by the business.  This would lower their personal Form 540 tax liability.  So the state still collects its total desired amount of tax, and the business owner still gets a full (indirect) deduction despite SALT limits.

      So where does this fit in?  Well, schemes to bypass SALT limits by allowing state credits for charitable contributions were previously shot down.  But this scheme can work, if the state does its part.  Unfortunately, it would only benefit owners of pass-through business entities, which is only a small portion of the total taxpaying population.  Some other states (NY  or NJ maybe?) have tried to implement similar schemes using employees instead of owners, I forget the exact details right now.

      This may become clear if you actually read the IRS notice.

      Certain jurisdictions described in section 164(b)(2) have enacted, or are contemplating the enactment of, tax laws that impose either a mandatory or elective entity-level income tax on partnerships and S corporations that do business in the jurisdiction or have income derived from or connected with sources within the jurisdiction. In certain instances, the jurisdiction’s tax law provides a corresponding or offsetting, owner-level tax benefit, such as a full or partial credit, deduction, or exclusion. The Treasury Department and the IRS are aware that there is uncertainty as to whether entity-level payments made under these laws to jurisdictions described in section 164(b)(2) other than U.S. territories must be taken into account in applying the SALT deduction limitation at the owner level.</i>

       

    • #279907
      Mark Bole
      Participant

      Here is a paper that discusses all three strategies – charity, payroll taxes, and pass-through entity business taxes.

      Search the web for “Salt Deduction Limitation: Can Highly-Taxed States Dodge the Bullet?” at scholarship.shu.edu for a PDF document that explains it all, including pros and cons.

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