How states are allowing small businesses to avoid the SALT cap on their tax returns

A growing number of states are using a workaround to help their taxpayers avoid a Trump-era cap on critical tax relief. It remains to be seen whether this will influence the ongoing pressure in Congress to repeal the cap entirely.

Colorado recently became the 14th state to embrace the new workaround, which allows (or in Connecticut’s case, requires) middle-tier businesses to pay state income taxes at the entity level rather than on their personal tax returns. For small businesses like partnerships, reporting this income as a business instead of passing it on to their individual tax returns means state taxes paid on that business income. do not count towards their SEL limit.

The new mechanism is called a flow-through entity tax (PTE), which is exempt from the $ 10,000 cap on state and local government tax deduction (SALT) that was part of President Trump’s 2017 tax reform. . For business owners in high property tax states like New Jersey and Connecticut, this is a critical change as it allows those taxpayers to deduct more of their local taxes from their other income. personal.

But it’s not just the blue states that use the tactic – the red states represent half of the states that have adopted it.

States are pushing ahead with these workarounds even as bipartisan support in Congress for the cap to be removed altogether increases. Rep. Thomas Suozzi (DN.Y.) joined on Wednesday with colleagues as well as local officials from New York, Ohio and the National League of Cities to report on their progress towards a repeal .

“It’s going to be another three months of negotiation,” Suozzi said. “It won’t happen tomorrow or the next day. But we keep getting more and more people in the House to say, “No SALT, no deal”.

On that call, Representative Young Kim (R-Calif.) Pointed out that setting a limit on state and local tax deductibility in 50 states with widely diverse economies and tax policies puts states like his at a disadvantage. In coastal California, median incomes exceed six digits, and the cost of housing is much higher than in the rest of the United States. This means that by default, Californians nominally pay more in state income and local property taxes than many other places.

“You can’t compare the median price of a $ 800,000 home here to the median price of a home in Oklahoma, for example,” she said. “Comparing California to others … and saying that a $ 10,000 cap is good for everyone doesn’t work. “

California is one of four states considering the new SALT tax avoidance solution.

Meanwhile, observers note that creating the workaround may even help level the playing field for some taxpayers compared to their counterparts in other states – but it adds to the inequalities within a state by promoting the transmission of income relative to wages.

For example, notes Kim Rueben of the Tax Policy Center, a partner in a law firm may be effectively exempt from the SALT cap while an executive assistant or partner in the same firm remains subject to the deduction limit.

But she predicts that the workaround will continue to work its way.

“While this complicates state taxes, it helps residents reduce federal taxes at no cost to the states themselves,” she wrote. “What a story.”

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