Just to jog your memory, you will recall that one of the most contentious provisions of the Tax Cuts and Jobs Act of 2017 was to deny individuals an itemized tax deduction for state and local taxes (SALT) paid in excess of $10,000. This particular provision hit many taxpayers in high tax states such as California pretty hard and increased their Federal tax burdens, particularly those in higher tax brackets.

Unfortunately, despite campaign statements to the contrary, the current Federal administration has been reluctant to change this rule because it is a revenue raiser and those in power don’t want to be seen as granting a big tax break to the wealthy.  A repeal of the SALT limit is not currently in any of the Biden tax proposals.

However, last year the IRS released a blueprint for a workaround in IRS Notice 2020-75 that would be acceptable to them. Several states had already drafted legislation to conform, and their citizens were able to reduce Federal taxes in 2020 as a result.  Yay for them!

But it’s taken until late last week for California to finally get on board the SALT train. Hey, at least they did it, and it will be retroactive for all of 2021.

How it works is this: for pass-through entities (think S corp, LLC, partnership and LLP’s) an election may be made at the entity level to pay state taxes on the entity’s income. That income will be taxed at 9.3%, and the tax thereon will be a deduction against Federal taxable income. This results in a lower Federal income that will appear on your k-1 form, creating a federal tax savings. The state tax you elect to pay will be passed through to the owners on their k-1 forms as a credit to be used against their individual California taxes.

Details are still sketchy, but it looks like you won’t need to pay the elected tax for 2021 until March 2022. Unused credits can be carried over for up to 4 years. And should the Federal Government someday pass legislation to eliminate the SALT limits altogether this legislation will expire.

The not-so-good news – If you are a sole proprietorship or a single-member LLC you won’t see this benefit that your competitors in other forms will get. If you are a wage-earning owner of a C corporation you won’t get this benefit either.

Keep in mind that any tax planning changes to the form of your organization you may be contemplating to grab these benefits will be prospective changes, and therefore time is of the essence if you are thinking it’s now time to make your C corporation or Sole proprietorship an S corporation.

Before you do anything along these lines I urge you to reach out to us here for guidance. We can do the math and update you on the latest rules so that you can make an informed decision.

As my cattle ranching grandfather used to say – “be careful you don’t step in something you can’t wipe off”.

Read more tax articles from Paul’s tax blog