SALT Cap Deduction Workaround for Business Owners Explained
If you're a business owner trying to understand how the SALT cap deduction affects you, you're not alone. This topic can be confusing, especially given recent changes that impact many taxpayers.
Understanding the SALT Cap
The SALT cap came into effect as part of the 2017 Tax Cuts and Jobs Act. Many high-earning individuals and those in states with significant taxes felt the impact most. This limit applies to those filing as individuals, heads of household, or married filing jointly.
The Pass-Through Entity Tax Workaround
Some states responded to the SALT cap by introducing a pass-through entity (PTE) tax. This workaround lets eligible businesses pay tax at the entity level. The business pays the state tax directly, often at the owner's personal income tax rate. That payment is then taken as a deduction on the federal tax return of the business, avoiding the personal SALT cap.
This means, instead of the owner claiming state and local tax as a personal itemized deduction (and being subject to the cap), the business itself claims the deduction, which is not restricted by the SALT limit. The business owner typically receives a state tax credit for the amount the business paid.
Which Entities Qualify
The workaround applies to specific businesses. Entities such as partnerships and S Corporations are most commonly eligible. Sole proprietorships and single-member LLCs don't qualify for the entity-level deduction because the IRS treats them as individuals for tax purposes.
States Participating in the Workaround
Not every state offers this solution. As of mid-2023, over 30 states had enacted PTE tax workarounds. Each has its own rules, deadlines, and forms. Some require an annual election. Others make it optional every year, while some require an initial irrevocable decision.
What Happens for Federal Taxes
PTE tax payments are considered a deductible business expense for federal tax purposes. This can reduce the overall taxable income of the business before the owner's share passes through to their personal return.
It's important to know the deduction only applies to taxes paid at the entity level, not the owner's personal state income tax payments.
Disclaimer:
The content provided on this blog is for educational and informational purposes only. It is not intended as legal, tax, or financial advice, and should not be relied upon as such. Laws and regulations vary by jurisdiction and may change over time. Readers are strongly encouraged to consult with a qualified professional—such as a licensed attorney, accountant, or tax advisor—for advice tailored to their specific situation.
