IRS allows some businesses to skirt cap on state and local tax deductions

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The Internal Revenue Service plans to issue proposed regulations to allow partnerships and S corporations to exceed the $10,000 limit on state and local tax deductions imposed by the Tax Cuts and Jobs Act.

The IRS issued a notice Monday saying the proposed regulations would clarify that state and local income taxes imposed on and paid by a partnership or S corporation would be allowed as a deduction when figuring its “non-separately stated taxable income or loss for the taxable year of payment,” so they wouldn’t be subject to the state and local tax deduction limits for partners and shareholders who itemize deductions.

The upcoming proposed regulations would apply to these types of income taxes starting Monday, and would also enable taxpayers to apply the rules to specified income tax payments made in a taxable year of a partnership or an S corporation ending after Dec. 31, 2017, and before the date when the upcoming proposed rules are published in the Federal Register.

The announcement would effectively provide the IRS’s approval to the types of workarounds that some states such as Connecticut, Louisiana, Maryland, New Jersey, Oklahoma, Rhode Island and Wisconsin have provided to businesses to circumvent the controversial $10,000 state and local tax deduction limitation in the 2017 tax overhaul, also known as the SALT cap. In these workarounds, businesses would pay the taxes at the entity level, as opposed to individually on the business owner’s or partner’s tax return, as is typical with pass-through businesses, and then would get a credit on their state tax returns, offsetting their individual tax liability. The Treasury Department has previously indicated that it would allow such workarounds, but hasn’t formalized its blessing.

“The Department of the Treasury and IRS are taking the necessary steps to provide fairness for America’s small businesses,” said Treasury Secretary Steven T. Mnuchin in a statement Monday. “These proposed regulations will offer clarity for individual owners of pass-through entities.”

The IRS building in Washington, D.C.
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SALT deduction IRS Tax deductions Tax regulations Pass-through entities State taxes