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An increasing number of states offer pass-through business owners an exemption from the $10,000 federal limit on state and municipal taxes. This is called SALT.
The controversial SALT write-off cap, which is a part of the 2017 Republican tax overhaul, is expensive for filers who itemize deductions. Filers can’t claim more that $10,000 for state income taxes and property taxes.
The limit has been a burden for those in high tax states such as New Jersey, California, New York. Although there has been some push to repeal the law President Joe Biden has not included the measure in his plans.
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Although Treasury and the IRS have blocked certain strategies to bypass the cap in some cases, some states have created workarounds for pass-through companies such as partnerships, Scorporations, and some LLCs.
In November 2020, the IRS issued guidance regarding these state-level tactics. It gave the green light to certain businesses.
According to the American Institute of CPAs (AICPA), more than a dozen states have adopted legislation to approve the workaround.
According to AICPA, there is currently legislation in Illinois, Massachusetts and Michigan, North Carolina, Oregon, Pennsylvania, and North Carolina.
Financial experts agree that while the maneuver can save tax for some business owners, it may not work in all cases.
Sharif Muhammad (certified financial planner) said that the devil is in details. He founded Unlimited Financial Services in Somerset, New Jersey.
How the tax on pass through businesses works
The majority of U.S. businesses are pass-through, meaning that profits flow to the owners’ individual tax returns.
The new bypass usually involves a state tax on these businesses that allows the company to pay a portion of the state income taxes.
The levy is typically paid by the pass through business. While some states allow for a deduction at the entity-level, others allow for a credit for taxes paid.
Last week, for example, Gov. California Governor Gavin Newsom signed legislation allowing certain businesses to pay an additional 9.3% tax on each owner’s portion of the company’s net income.
Participants may be eligible for a credit on their California tax returns equal to 9.3% tax
“You’ve effectively prepaid your state taxes on your pass-through income,” said Perry Ghilarducci, a CPA and partner at Avaunt Ltd. CPAs & Consultants in Sacramento, California.
It is not right for all businesses
These workarounds can be a welcome relief to business owners who pay tens of thousands in state and property income taxes each year.
Muhammad says it’s important to look at the numbers before making decisions.
He said that business owners should review their taxes at both the personal and entity levels. For example, if they do not itemize deductions, the benefits might not be as significant.
Ghilarducci also said that a business owner in a lower income bracket may pay more state levies.
Muhammad said, “The numbers must be laid out, and everyone has a different situation.”