How States Are Letting Small Businesses Avoid The SALT Cap On Their Tax Returns

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A rising number of states are employing a loophole to assist their residents in avoiding a Trump-era cap on a key income tax deduction. It remains to be seen whether it will have an impact on the continuing effort in Congress to eliminate the cap entirely. Colorado just became the 14th state to approve the new workaround, which permits (or, in the case of Connecticut, forces) pass-through corporations to pay state income taxes at the entity level rather than on their individual tax returns. Small firms, such as partnerships, can avoid having their state taxes count against their SALT cap by declaring their revenue as a company rather to transferring it through to their individual tax returns.
The new method is known as a pass-through entity (PTE) tax, and it is exempt from President Trump’s 2017 tax reform’s $10,000 cap on the state and local tax (SALT) deduction. It’s a significant move for business owners in high-tax states like New Jersey and Connecticut since it allows them to deduct more of their local taxes from their other personal income.
However, the approach isn’t exclusively used by blue states; red states account for half of the states that use it.

A SALT solution for pass-through firms is currently in place in 14 states, with four more contemplating it.
States are pushing ahead with these workarounds, according to the Urban Institute Tax Policy Center, even as bipartisan support for eliminating the ceiling grows in Congress. Rep. Thomas Suozzi (D-NY) joined colleagues and municipal leaders from New York, Ohio, and the National League of Cities on Wednesday to discuss their progress toward repealing the law.
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“It’ll take another three months of negotiating,” Suozzi said. “It’s not going to happen today or tomorrow. But we’re bringing more folks to the House floor every day to say, ‘No SALT, no agreement.'”
Rep. Young Kim (R-Calif.) said on the conference that limiting the deductibility of state and local taxes across 50 states with vastly different economies and tax policies disadvantages states like hers. The cost of living in coastal California is substantially greater than the rest of the country, with typical salaries exceeding six figures. Californians, by default, pay marginally more in state income and municipal property taxes than residents of many other states.
“You can’t compare the median property price here of $800,000 to the median home price in Oklahoma, for example,” she explained. “Comparing California to other states…and claiming that a $10,000 ceiling is helpful for everyone isn’t going to cut it.”
The new SALT tax loophole is being considered by four states, including California.
Meanwhile, experts point out that while the workaround may assist certain taxpayers level the playing field with their counterparts in other jurisdictions, it exacerbates imbalances within a state by favoring pass-through income over wages.
A partner in a legal firm, for example, can be effectively exempt from the SALT limits while an executive assistant or associate in the same firm is subject to the deduction limitation, according to Kim Rueben of the Tax Policy Center.
She believes, however, that the workaround will continue to gain popularity.
“While it complicates state taxes, it aids residents in lowering federal taxes at no expense to the states,” she wrote. “What a bargain.”/nRead More