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September 13, 2023 The Tax Lawyer

SALT Substitutes and Other Workarounds

Vol. 76, No. 4 - Summer 2023

by Karen C. Burke


In response to the Tax Cuts and Jobs Act of 2017, many states have enacted elective entity-level passthrough taxes that allow business owners to circumvent the individual cap on deductibility of state and local taxes (SALT), reducing federal tax revenue at no cost to the states. Entity-level workarounds purport to shift state income tax liability from the owners’ personal tax returns to the entity’s tax return. The passthrough entity claims an uncapped ordinary business deduction for state income taxes, reducing the owners’ adjusted gross income for federal tax purposes; state income tax credits roughly equal to the entity-level tax reduce or eliminate the owners’ state tax liability. In Notice 2020-75 the outgoing Trump administration blessed entity-level workarounds, violating fundamental principles of conduit taxation that seek to treat passthrough owners as if they conducted the entity’s business individually. Because elective entity-level taxes function as nearly perfect substitutes for individual income taxes, they should be required to be separately stated and deducted at the individual level, subject to the SALT cap. Allowing passthrough owners the equivalent of an abovethe- line deduction for state income taxes is inconsistent with the concept of adjusted gross income which Congress introduced in 1944 to establish rough parity between business and nonbusiness taxpayers regardless of source of income. Notice 2020-75 conspicuously fails to explain why the separate statement rules do not apply to elective entity-level taxes; it also ignores longstanding guidance concerning the business–nonbusiness distinction and the meaning of “state taxes on net income.” Whether or not Congress retains the SALT cap, Notice 2020-75 should be rescinded.

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