Passthrough Entities Tax Loophole update

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Tax practitioners still are working to identify clients who will benefit from the tax law changes of the Passthrough Entities Tax Loophole (PTET), also known as the SALT cap workaround. The cap to sales and local tax (SALT) deductions came as part of the 2017 Tax Cuts and Jobs Act.

The act essentially capped all SALT deductions for individuals on their form 1040, under itemized deductions to $10,000. For individuals living in high-income tax states, that significantly limited the deductions they were entitled to take.

In a not-so-direct response, states have now started trending towards allowing more passthrough entity taxes or PTETs. Currently, 16 states have enacted these tax workarounds for 2021 tax year with at least six more following in 2022.

Essentially, what happens with PTETs is passthrough entities, such as S Corps and partnerships can pay state taxes at the entity level for states that have elected to allow these workarounds. The deduction for state-level taxes can then be taken by the entity itself before passing income through to the owners. By using this methodology, the deductions are not limited to the $10,000 cap at the 1040 level.

Be careful when considering this strategy with clients. Not every state has adopted the PTETs workaround as an option. Additionally, many states require passthrough entities to elect IN to the option as opposed to it being automatic.

Practitioners need to carefully examine their client list for who may be:

  1. Exceeding the SALT deduction on their personal return
  2. Also be an owner of a passthrough entity
  3. That passthrough entity has a tax liability in a state that allows for the PTET election

Then, the option to make the election can be examined for the intended benefits. Multi-state passthrough entities may offer a bigger benefit. In cases where this workaround works for a client though, the savings potentially is significant and worth the time it takes to examine the options.

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