At the end of last year, there was a large push by New York business owners to use a state-approved system for avoiding the $10,000 federal cap on state and local tax deductions.
This workaround had owners of closely-held businesses pay the state $11 billion into New York’s new pass-through entity tax by the end of 2021. This is a different process than what has been used in the past, where pass-through businesses wouldn’t pay income taxes directly, rather pass the income and deductions through to their owners’ individual returns.
Paying $11 billion in taxes may not seem like a good thing, but since business owners shifted their state income from their individual return, where the SALT cap would pinch them, to their business return, where the cap does not affect them. However, based on the number of business owners, and assuming all had a 32% federal tax rate; it is estimated that these business owners saved over $3 billion through pass-through entity taxes.
Why did New York do This?
This latest push from New York was just the latest move made by a state to combat the $10,000 limit on deducting SALT, which has caused business owners to face a high tax burden with limited deductions. New York Assemblywoman Amy Paulin backed New York’s adoption of PTETs saying, “New York was harmed in the change to SALT and this was one way of remedying some of that harm. Otherwise, our high earners are going to flee.”
Similar laws have been rolled out by other States with details varying, but all following the same general process: States impose taxes (often optional) on pass-through entities, these taxes are paid before income flows to business owners which allows for the use of more deductions.
Wrap Up
The pass-through workaround to the cap has been bipartisan and spread across Republican and Democratic states after the Treasury Department blesses it in 2020. The Biden administration has not shown any interest in reversing the decision to strengthen enforcement of the limit and has left the issue almost entirely to Congress.
Did you take advantage of PTET last year? For a better understanding feel free to give us a call at 516-541-6549.