State Level PTETs

The 2017 tax form legislation imposed a $10,000 cap on the federal tax deduction for state and local taxes (known as the “SALT cap”). In response, many states have created pass-through entity level taxes (“PTETs”, which can be mandatory or optional). The IRS has stated that the entity itself would therefore be entitled to deduct these taxes if they are paid to the state or local jurisdiction and that these “PTETs” are not included when applying the SALT cap to the individual partner, LLC member or S corporation shareholder. To date, 35 states and one local government have created these PTETs as SALT cap workarounds.

We asked two professors and authors of ALM’s Tax Facts with opposing political viewpoints to share their opinions about states using pass-through entity taxes to offer taxpayers a way to “work around” the $10,000 SALT cap.

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

Their Votes:

Byrnes

Bloink

Their Reasons:

Byrnes: These types of entity-level taxes are completely legal. Even the IRS has blessed their use. The SALT cap itself unfairly targets Americans who live in high-tax states by creating a cap that isn't even often relevant to taxpayers who live in lower tax states. That's patently unfair, and it makes absolute sense that higher-tax states should offer a workaround to avoid having these taxpayers flee to low-tax states.

Bloink: We all know that these pass-through entity taxes are a way to avoid the $10,000 SALT cap limitation. That SALT cap was implemented as a way to offset the tax cuts offered to major corporations and wealthy Americans in the 2017 tax reform legislation. Regardless of the IRS' statements, Congress clearly did not intend to allow for a way to "work around" this SALT cap limitation--or they wouldn't have created it in the first place.

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Byrnes: The SALT cap itself creates a perverse incentive for the wealthiest Americans to relocate to lower tax states--leaving only middle-income taxpayers in high-tax states to shoulder the burden of this unfair revenue-raiser. This is the precise reason that higher tax states are offering these taxes in the first place—to protect small business owners who need tax relief in order to be able to afford staying in their original jurisdiction.

Bloink: We have to remember that the SALT cap limitation is one of the few revenue-producing provisions that actually allowed the 2017 tax reform legislation to pass in the way it did in the first place. Allowing states to simply give wealthy taxpayers a loophole goes against Congress' intent and really should never have been permitted in the first place.

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Byrnes: If we're looking to minimize the impact on middle class Americans, we should have a version of the SALT cap that draws the line based on income. Without a limitation like that, we need to look to alternatives to allow taxpayers to continue paying a reasonable rate of tax. These state level entity taxes give our small business owners the protection they need and deserve.

Bloink: These workaround taxes give wealthy Americans yet another way to avoid paying their fair share of taxes. We need to be pushing back against any attempts by state and local governments to create new tax loopholes for wealthy Americans.