Congress and the President made the first move capping the deduction for state and local taxes (SALT) at a mere $10,000. States were quick to fire back by dreaming up all sorts of alternative schemes to work around the limitation. Some of these included the recharacterization of certain tax obligations, such as property taxes, to charitable contributions. While many of these transformative schemes were questionable from the beginning, the IRS made their move this summer by finalizing regulations effectively stunting most of the SALT workaround strategies.
One workaround that wasn’t addressed, and many still believe can be successful in circumnavigating the cap is the so-called entity level tax. What six states have done, New Jersey being the most recent, is to impose a tax on partnerships, S corporations and other flow-through entities, thereby allowing a deduction at the business level. A corresponding credit is allowed on the pass-through owner’s tax return.
New Jersey (Connecticut, Wisconsin, Oklahoma, Louisiana and Rhode Island being the other states that have already done so) just last week enacted an elective pass-through entity tax in hopes of mitigating the limitation on the SALT deduction. The entity has until the due date of the tax return to make an annual election to participate. If an election is made, the entity will pay a tax on its New Jersey source income and the partners, members or shareholders will receive a dollar for dollar credit on their New Jersey Gross Income Tax Return. Of the six states implementing a similar tax, Connecticut is the only one where the tax is not elective, but mandatory.
The details of the New Jersey legislation will be outlined in a soon-to-be-released Berdon Client Alert. If you have questions contact me at firstname.lastname@example.org or your Berdon Advisor.
Wayne Berkowitz, a tax partner and co-leader of the State and Local Tax Group at Berdon LLP, advises on the unique requirements of governments and municipalities across the nation.