The IRS is contemplating this workaround to keep away from the state and native tax cap
The offices of the Internal Revenue Services in Washington, DC
Adam Jeffery | CNBC
The IRS has signaled that it will bless a workaround that will allow small business owners to bypass the $ 10,000 limit on state and local income tax deductions.
Since the Tax Cut and Employment Act went into effect in 2018, high-tax countries have been looking for ways to help individual taxpayers listed on their tax returns cope with the $ 10,000 limit.
Last year, the IRS and Treasury blocked one of those strategies, laws in New York, New Jersey, and Connecticut that would have allowed municipalities to create charitable funds to pay for local services and offer property tax credits to incentivize homeowners.
States have also devised another workaround, this time using pass-through companies that include suburban companies, some limited companies, and partnerships.
The IRS has just given the green light to this move, according to a notice from the agency released last week.
This workaround took effect in seven states under the Tax Cut and Jobs Act, according to the American Institute of CPAs: Connecticut, Louisiana, Maryland, New Jersey, Oklahoma, Rhode Island, and Wisconsin.
Four other states have proposed laws but failed to enact a rule: Alabama, Arkansas, Michigan, and Minnesota, according to the AICPA.
However, the workaround does not apply to sole proprietorships and sole proprietorships.
“This was an area of concern in the taxpayer community as to whether the IRS would allow these SALT workarounds,” said Harold Hecht, CPA, chief executive officer, state and local tax services at Mazars USA.
“It is really good news that the IRS is issuing these guidelines that accept pass-through corporate taxes as a valid workaround,” he said.
Entity versus individual
Pass-through businesses are known as such because the business “passes” income on to its owners.
These owners report their share of business income when filing their individual income tax returns. There they are subject to the US $ 10,000 limit for state and local income taxes.
Here’s how the pass-through workaround works, according to AICPA: The company itself – not the owner – would be responsible for state taxes on the company’s income. In the meantime, the owner can request a credit on their government tax return for the tax paid by the company on their share of income.
More from Smart Tax Planning:
Open a side business? First, master these tax tips
This is the maximum you can save on your 401 (k) plan in 2021
Here are the new tax brackets for 2021
The proposed rules of the IRS and Treasury Department will make it clear that state taxes paid by the company are deductible by partnerships and S-Corps when they calculate their federal income and distribute it to owners, according to Eileen Sherr, CPA and Senior Manager, AICPA Tax Political Advocacy.
Discussions with your tax advisor
Once the IRS issues its regulations, more states are likely to be evaluating similar workarounds.
“States get their tax dollars regardless, but they allow businesses to get federal benefits and the IRS is okay with that,” said Albert J. Campo, CPA and managing partner at AJC Accounting Services in Manalapan. New Jersey.
That said, it’s time for small business owners to speak to their tax professionals about whether they qualify – and, if applicable, whether it’s time to change tax returns.
For example, Connecticut was the first to introduce its workaround and rolled out in 2018. Pass-through owners may want to change their old returns, said Michael D’Addio, principal at Marcum LLP.
“If you didn’t make the deduction at the company level because you were concerned the IRS wouldn’t allow it, see if there is a refund option,” he said.