For tax years 2018 through 2025, the Tax Cuts and Jobs Act of 2017 (TCJA) limits individual itemized deductions for state and local sales, income, and property taxes (referred to as SALT) and SALT deductions in the case of trusts and estates. The limitation is $10,000. The law does not affect the above-the-line deduction for taxes incurred and paid in an active trade or business or an activity entered into for profit.

Many states recently enacted “SALT cap workaround” legislation enabling pass-through entities (PTE) to deduct entity-level SALT payments as a business expense in place of non-deductible itemized deductions over the “SALT cap” of $10,000 per individual tax return. Currently, 21 states have enacted this legislation, and others are considering it.

The SALT cap workaround is not automatic in most states.  The owner must file an election for PTE treatment by the deadline, which varies by state. The PTE election deadline for New York State is October 15, 2021. Connecticut’s pass-through entity (PTE) tax for the SALT cap workaround is mandatory, which is unique.  In most states, the owner can make the election with a timely filed tax return, which is more convenient.

Since the TCJA passed, 21 states have enacted legislation to partially mitigate the limit on individual state tax deductions by allowing pass-through entities to elect to have state income taxes directly imposed on the entities. Previous state attempts around the rules, such as tax credits for charitable donations, did not meet federal approval. The IRS released Notice 2020-75 in November 2020 announcing its intention to issue proposed regulations authorizing the entity-level tax as an acceptable workaround to the $10,000 cap under the TCJA.

As of November 30, 2021, the following states have implemented entity-level income taxes for pass-throughs:

Alabama, Arizona, Arkansas, California, Colorado, Connecticut, Georgia, Idaho, Illinois, Louisiana, Maryland, Massachusetts, Minnesota, New Jersey, New York, North Carolina, Oklahoma, Oregon, Rhode Island, South Carolina, Wisconsin,

In addition, Ohio, Michigan, and Pennsylvania have similar bills at various stages of implementation.

The general state framework looks something like this:

1. Make an annual election during the year of intended effect up to the due date for filing the original return, including extensions. Some states have a specific form for the election; some elections may be made by checking a box on a timely filed return. Connecticut currently is the only state where the entity-level tax for pass-throughs is mandatory. The election can’t be changed for a number of years in some cases.
2. For the most part, the election applies to S corporations and entities taxed as partnerships for federal income tax purposes. In a couple of cases, business or statutory trusts and sole proprietorships may elect the entity-level tax.
3. In general, the tax rate is the highest marginal income tax rate for individual and/or corporate taxpayers in the state. Many states have a flat tax rate; other states impose a graduated tax rate.
4. States may provide a deduction, exclusion, or credit to resident taxpayers based on the amounts taxed at the entity level to prevent double taxation. Some states limit the credit to roughly 90 percent. Some credits are nonrefundable and may carry forward. In general, each state provides a credit equal to the amount of similar tax paid to other states. The rules for nonresident partners vary. Some states have restrictions if any members, partners, or shareholders are pass-throughs or corporations.
5. Most states allow net operating loss carryforwards (or carrybacks).