A State-Level Solution to the Federal SALT Limitation
If you’ve been paying taxes for the past few years, you are likely well-acquainted with the cap on deducting state and local taxes (SALT) on your personal tax returns. This limitation was part of the Tax Cuts and Jobs Act of 2017. Under this rule, you sum up your state income taxes, local property taxes, etc. for the year and subject this total to a maximum of $10,000 before claiming the deduction on your personal tax return, Schedule A. For example, if your property taxes for the year were $8,000 and your state income taxes paid were $30,000, you would otherwise have a SALT deduction of $38,000, but instead you’re maxed out at $10,000. This leaves $28,000 on which you have to pay taxes.This is bit of a bummer, isn’t it? In reaction, states have tried workarounds, such as converting state tax payments into charitable contributions – to which the IRS said no. You can certainly continue participating in these charitable programs but receiving a charitable contribution deduction for doing so is now practically impossible. A more recent approach is the “Pass-Through Entity”¹ strategy by which business’ whose owners pay tax on business profits – such as S Corporations and partnerships – can pay state taxes at the business level where there is no SALT deduction limitation. The IRS is actually on board with this strategy so far, so it’s definitely worth taking a look.Nearly 25 states have adopted, or are considering the adoption of, this strategy. With different states approaching it differently – various effective dates, mechanisms, voluntary v. mandatory, etc. – this article will focus on Georgia. Georgia’s PassThrough Entity (PTE) regime, pursuant to House Bill 149, takes effect for tax years beginning on or after January 1, 2022. As such, businesses operating in Georgia as partnerships or S Corporations can consider this strategy as part of their tax planning for the upcoming year.
2022 Georgia First-Year PTE Mechanics
Step 0: Consult your tax advisor to see if this strategy is an option for you. As you’ll read later in this article, it’s not a slam dunk.
Step 1: Calculate Georgia PTE tax of 5.75% on expected 2022 Georgia taxable income. Consider making estimated tax payments during 2022, which the state expects if PTE income will exceed $25,000.
Step 2: To avoid ambiguity regarding payment timing v. deduction, pay 2022 expected PTE tax liability less any estimated tax payments by December 31, 2022.
Step 3: In 2023, deduct the PTE state taxes paid in 2022 on the company’s 2022 timely-filed federal business tax return. Reminder, the company still isn’t paying taxes at the federal level, but instead is reporting a reduced amount of income to company owners to reflect on their own personal income tax returns.
Step 4: In 2023, company owners report on their 2022 personal income tax returns the 2022 taxable income that has been reduced by the state taxes paid by the company. This compares to the default reporting of not paying the state tax at the company level, reporting a higher level of federal taxable income, and possibly being disallowed some amount of state income tax deduction on the owner’s personal tax return, Schedule A.
The Georgia PTE strategy might work for:
Those at higher levels of income. The benefit to a PTE increases as your income increases because a) you’ll likely be paying more in state taxes and b) the tax benefit of deducting those state taxes increases due to increasing marginal tax rates. Keep in mind that your personal tax brackets are reflective of your overall tax situation, not just your business activity. Looking at your business activity alone will not be sufficient to determining if a PTE strategy is appropriate.
Businesses that keep current and accurate financial and tax records. These companies will have the needed information to make advanced analyses of whether the PTE strategy will create sufficient cash savings on a year-by-year basis.
Taxpayers who haven’t itemized in the last few years due to the SALT limitation. If the reason you haven’t itemized is due to a hefty state income tax bill that’s over the $10,000 maximum, a PTE strategy might work for you as long as the state taxes are primarily related to a PTE-eligible business. Remember, the PTE strategy won’t help you deduct all your excess SALT payments, only those related to your business.
The Georgia PTE strategy is not the best fit for:
Late tax return filers. The business must decide annually to be taxed this way and must do so by the extended due date of its tax return.
Business owners who may change their minds about a PTE situation. The election for PTE treatment, made with the related tax filing, is irrevocable.
Businesses without current and accurate financial and tax records. An annual analysis will be needed to determine the cost v. benefit of filing one way over the other so you can potentially make PTE estimated tax payments before the end of the applicable tax year. This analysis will not be feasible for those who can’t readily quantify income levels. Additionally, the owner’s personal tax situation will need to be assessed as part of the analysis, so good record keeping at that level will be required, as well.
Companies with corporate owners. Although corporations aren’t typically allowed as S Corporation owners, they are eligible to be partnership owners. If your partnership has a corporate owner, it will be precluded from participating in Georgia’s PTE option.
A company not currently doing business as an S Corporation or a partnership. These companies may find the potential benefits of a PTE strategy still don’t outweigh the one-time and ongoing costs of operating as an S Corporation or a partnership. Also consider sunsetting, repeal, or alterations to the federal SALT deduction limitation that would reduce the desirability of semi-permanent business restructuring performed simply to meet PTE rules.
Companies that have significant business outside of Georgia. If a decent portion of your work is out of Georgia, approach Georgia PTE options carefully. The Georgia PTE rules disallow deductions for state-level income and gross receipts taxes and do not allow for out-of-state tax credits offsetting Georgia tax.
Companies that have multiple owners. Businesses owned by more than one person should also approach Georgia PTE options carefully. Remember, whether this strategy is advantageous depends on each owner’s tax situation. With various individual tax situations in the mix, it’s possible to not come out ahead in a PTE situation.
Companies that only do business in states without a personal income tax. This point applies to PTE strategies across all states. In general, note that Pass-Through Entity treatment is a moot concept for companies doing business only in states that don’t have a personal income tax. For example, if you are an S Corporation business owner in Texas and your company does business solely in Texas, there is no PTE option for you. On the other hand, you’re also not paying state income taxes at your personal level in the first place.
Next steps
If you’re in the “who this might work for” category, contact your tax advisor to discuss further and possibly have them assist with a bespoke analysis of your specific situation. As always, if you have any questions about any of the points raised in this article, feel free to reach out to me at amcleod@atlanta.tax.
¹ “Pass-Through Entity” is a moniker historically used by tax professionals and taxpayers in a variety of contexts to collectively discuss S Corporations, partnerships, and sometimes single-member LLCs. In this context, however, the term “Pass-Through Entity” or “PTE” refers exclusively to the state-level strategy of taxing eligible businesses at the business level solely as a workaround for the federal SALT deduction limitation.
