Entity-Level Tax for Pass-Through Entities Provides Workaround to $10,000 SALT Cap

July 20, 2021
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On May 4, 2021, Georgia legislators passed the SALT Parity Act of 2021. This introduces a new entity-level tax to Georgia pass-through businesses.

Typically, Georgia-source business income earned by partnerships and S corporations is passed down to the individual owners responsible for paying the resulting tax. The SALT Parity Act permits partnerships and S corporations to elect to be taxed at the entity level. Not only will this election change how businesses and individuals report state business earnings, but it will also effectively revive a state and local tax deduction that many taxpayers lost in 2018.

But before we get into the consequences of this law, let’s review exactly how the tax law changed.

More About Georgia House Bill 149

Georgia House Bill 149 (H.B. 149), which has been named the SALT Parity Act of 2021, amended the Georgia tax code by allowing owners of pass-through entities to make an election to pay their Georgia business income taxes at the entity level. When they make this election, state business earnings will be taxed at a flat rate of 5.75%. Individual owners can exclude their respective share of Georgia business income from their personal tax returns.

Pass-through entities can make this election annually beginning in 2022. Once elected for that tax year, the election cannot be revoked.

This election is only available to pass-through entities that are 100% owned by natural persons. If even one partner or shareholder is an entity (like another S corporation), the entity-level tax is no longer an option.

Georgia Entity-Level Tax Circumvents the SALT Cap

Georgia H.B. 149 was passed in response to the $10,000 SALT deduction limitation imposed upon individual taxpayers at the federal level. When Congress passed the Tax Cuts and Jobs Act (TCJA), it limited individuals’ state and local tax (SALT) deductions to $10,000 beginning in 2018. SALT deductions are reported alongside other itemized deductions and include the following types of state and local taxes:

  • Property taxes
  • Income taxes or sales taxes

By limiting the amount of state and local taxes they could deduct, some taxpayers received little to no federal benefit from paying Georgia (and other states’) taxes.

The individuals this limitation affected the most were taxpayers located in jurisdictions with high tax rates. Individuals living in states with high income tax rates (like California and Washington D.C.) and states with high property tax rates (like localities in New York and New Jersey) quickly met their SALT cap and could not carry forward any of the disallowed deductions.

Georgia H.B. 149 circumvents this SALT deduction limitation by converting individual earnings into business earnings. Because the business pays the Georgia income tax, the company can deduct those SALT liabilities on their federal return. In other words, a deduction that was limited for individuals is unlimited for their business.

Other States Have Similar Programs

Georgia isn’t the only state to have created a SALT cap workaround; New Jersey, New York, Oklahoma, and a handful of other states have enacted similar entity-level taxes. Fortunately, the IRS recognizes this tactic as a viable workaround to the SALT deduction limitation. IRS Notice 2020-75 states:

“The Department of the Treasury and the IRS intend to issue proposed regulations to clarify that State and local income taxes imposed on and paid by a partnership for an S corporation on its income are allowed as a deduction by the partnership or S corporation in computing its non-separately stated taxable income or loss for the taxable year of payment.”

To fall under the IRS’s protection, two things must happen: (1) state taxes must be paid for by the business, and (2) individuals are not permitted to take credit for state taxes paid by the business.

Determining if Entity-Level Tax is Right for Your Business

Georgia businesses should weigh the pros and cons of electing this entity-level tax. Here are a few things you should think about.

  • Non-Resident Owners
    Electing the pass-through entity tax could benefit Georgia business owners at the expense of Georgia non-resident owners. Owners who live in other states can typically take a tax credit in their home state for taxes paid to the state of Georgia. If the entity-level tax is elected, this credit evaporates. It’s possible that the federal tax benefits of receiving a full SALT deduction would not outweigh the loss of a credit for taxes paid to other states for Georgia non-residents.
  • Current SALT Limitations
    The $10,000 SALT deduction limitation is only temporary. Beginning in 2026, the SALT deduction reverts to pre-TCJA law with no dollar cap. This entity-level tax might not be as much of a concern when the SALT cap expires in 2026.
  • Who Itemizes vs. Who Takes the Standard Deduction
    If most owners take the standard deduction, the SALT cap might not even be a concern.

If you want to learn more about this new Georgia pass-through entity tax, please reach out to our MST CPAs. We can help you determine if making this election is the best move for your business.

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