The recent tax and spending megabill significantly increased the cap on state and local taxes, from $10,000 to $40,000, with the higher limit subject to a phaseout when taxpayers’ income exceeds certain threshold amounts.

After the 2017 tax overhaul, many states created pass-through entity tax (PTET) as a workaround for the $10,000 cap. The business pays the PTET at the entity level and is then able to deduct the payment as a business expense on its federal income tax return. This reduces the business’ taxable income and the amount of that income that is passed through to the individual business owner.

The Internal Revenue Service in 2020 agreed that these PTETs are not included when applying the SALT cap to the individual partner, LLC member or S corporation shareholder. This essentially allows taxpayers who use the pass-through entity structure to sidestep the SALT deduction cap. The July spending bill did not address the PTET issue.

We asked two professors and authors of ALM’s Tax Facts with opposing political viewpoints to share their opinions about whether the Trump administration and Republican-controlled Congress should take action to limit the use of SALT-related PTETs.

Below is a summary of the debate that ensued between the two professors.

Their Votes:

Bloink

Byrnes

Their Reasons:

Bloink: The $40,000 SALT cap, coupled with income phaseouts for the highest income taxpayers, was a compromise position that allowed this [legislation] to pass. By failing to address the PTET "workaround" option, that compromise position seems, well, compromised. The administration absolutely should take steps to challenge the IRS 2020 Notice that allowed these PTET workarounds to stand.

Byrnes: It seems clear that the [spending bill] left the PTET workaround concept alone because blue state Republicans would not have supported the legislation otherwise. The income phaseout for the OBBB helped with the bill's scoring, allowing it to pass muster and gain the support of fiscal hawk holdouts. That said, if the bill simultaneously eliminated the PTET possibility, high-income taxpayers from high-tax states would actually be stuck with the $10,000 cap regardless of their business situation.

Bloink: Many in the GOP agreed to the increased cap because the phaseout was supposed to limit the cost of that significant increase. Now, the wealthiest taxpayers remain able to work around that phaseout by continuing to use a complicated entity-level tax regime to skirt the $10,000 cap that they'd continue to be subject to given the phaseout.

Byrnes: Now that the PTET possibility remains standing, it doesn't appear that the current administration will be inclined to challenge it, at least not between now and the midterms. The fact is that even if the IRS did not release their promised regulations, they informally blessed the strategy and now taxpayers have come to rely upon its availability. Given the current political climate and ongoing budget negotiations, eliminating the PTET workaround is definitely on the back burner.

Bloink: The PTET issue is one that simply must be addressed. We cannot go on allowing the wealthiest taxpayers to exploit these loopholes in the tax law. The SALT cap, while controversial all around, was imposed to allow this law to be passed without any bipartisan support — to pay for tax breaks that primarily benefit the wealthiest Americans. Now, by allowing the PTET workaround to stand, the GOP is continuing yet another tax break for those Americans who have already benefitted most from the Trump tax law.

Byrnes: The PTET workaround really is a gray area, and I am surprised that it hasn't yet been subject to significant legal challenges. Still, I don't think anything happens at the congressional level, at least not in the near term. Far too many taxpayers have come to rely on the PTET option to increase the overall value of their state and local tax deductions at the federal level.

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