The top SALT stories of 2021

Heading this year’s list are the pass-through entity state tax regimes enacted as a workaround to the Tax Cuts and Jobs Act’s SALT Cap. “Any year in which you have 15 states react to a development, that will land it at or near the top of the list,” said Yesowitz.

In 2018, states first began enacting elective PTE tax regimes in reaction to IRS Notice 2020-20, which clarified that state and local income taxes imposed on a partnership or S corporation — PTE taxes — are deductions allowable in computing the non-separately stated income of such entities.

“An interesting component of state activities is the diversity in approaches for the different states,” said Yesnowitz. “Under these regimes, the PTE is permitted to deduct its state and local income taxes as a tax on the business at the federal level, followed by a deduction for the PTE tax on the distributive share of the owner’s income. Depending on the structure of the PTE tax, the owner generally claims a corresponding tax credit against personal tax liability or an exclusion on the portion of the owner’s pass-through income subject to the entity tax.”

Seven states enacted PTE taxes prior to Notice 2020-20, when the IRS said that PTE tax regimes would be respected for federal income tax purposes, according to Yesnowitz. “Since that time, states moved at a rapid pace to adopt their own elective state PTE regimes, with 14 additional states having done so in 2021,” he said. “Notably, New York adopted a PTE tax as part of its 2022 fiscal year budget in April 2021, first applicable to the 2021 tax year.”

While the fate of Build Back Better is not yet clear, Yesnowitz feels that if something is passed, “changing the SALT cap will likely be a component of that.”

The American Rescue Plan Act created the Coronavirus State Fiscal Recovery Fund and the Coronavirus Local Fiscal Recovery Fund, which offered state governments hundreds of billions of dollars to assist with recovery from the economic damage inflicted by COVID. However, as part of the legislation, states are required to use the funds for either a wide variety of pandemic-related purposes, or to make necessary investments in water, sewer or broadband infrastructure. The legislation prohibits states from using the funds to offset a reduction in state net tax revenue resulting from a change in law, regulation or administrative interpretation during a period that reduces any tax, or from depositing the funds into a pension fund. States have responded with a number of lawsuits challenging the constitutionality of the provision.

The mandate has led to a number of constitutional challenges, resulting in three significant court decisions during 2021 granting injunctive relief against enforcement, with further challenges remaining outstanding. Despite federal court losses in the three cases, the Treasury has left the tax mandate largely unchanged in its new final rule.

“Given the distinctive and compelling sovereignty issues raised by the ARPA tax mandate, the potential conflicting views of different circuit courts, and the effect that the mandate could have on future state taxation policies, it may only be a matter of time until the ARPA tax mandate controversies are raised before the Supreme Court,” Yesnowitz predicted.

The ongoing nature of the pandemic, with delta and omicron variants continuing to pose risks, has led to changes in workplace arrangements, Yesnowitz noted. “That has led to significant issues. Continued remote work brought new state and local tax challenges for employers in 2021, as taxing authorities began rescinding temporary payroll tax withholding and nexus policies, many of which were in effect since the early days of the pandemic,” he explained. “As a result, businesses growing mobile workforces were left to navigate conflicting state and local tax approaches to remote work in 2021.”

Massachusetts adopted a temporary emergency regulation that allowed it to tax the income of nonresident employees who worked in the state prior to the pandemic, but who were teleworking during the pandemic. In response, New Hampshire, which does not impose a personal income tax, asked the Supreme Court to rule on whether Massachusetts could constitutionally tax nonresidents working in New Hampshire and lacking a connection with the taxing state during the pandemic.

“We had thought there was a possibility that the court would take the case,” said Yesnowitz. “We were somewhat disappointed that it didn’t decide to hear the case. Potentially, they may have denied [certiorari] because of the temporary nature of the Massachusetts legislation that was being questioned.”

“Expiring administrative guidance in 2021 is likely to impact companies with employees working in locations different from their traditional location prior to the pandemic,” he observed. “Some companies may have started tracking employee location for the first time to make accurate payroll tax reporting and business tax filing decisions. Others may have given more thought to crafting policies setting remote work parameters to minimize additional tax withholding and filing obligations. Beyond 2021, employers will likely need to revisit their policies and update their systems and processes on a regular basis to address the continued disparity in state tax approaches to remote work.”