In efforts to mitigate the impact of the newly-created federal cap on SALT deductions for individual taxpayers, several states have enacted, or are exploring, entity-level taxes on pass-through entities (PTEs) as a novel workaround. However, these entity-level tax systems, and their associated individual credits, risk introducing unnecessary complexity into state tax systems.
These entity-level initiatives from states like Arkansas, Connecticut, and New York appear to be part of a broader set of efforts to combat the SALT deduction limitation created by the 2017 tax act, as Bloomberg Tax has detailed in recent coverage. This activity is occurring even as the Treasury Department has published proposed regulations that attempt to limit the efficacy of charitable contribution workarounds, as Bloomberg Tax’s Ernst Hunter notes in a Aug. 24 blog post.
However, Treasury has yet to respond to the recent influx of entity-level PTE taxes that have progressed in the same vein as the charitable contributions workarounds. While charitable contribution workarounds would target a broad base of resident taxpayers in high income tax states like California and New York, PTE tax workarounds only benefit those high-income residents who have material income from PTEs.
Although the move towards entity level taxation of PTE income should benefit resident partners or owners on their federal tax returns, the potential for “double taxation” on nonresident partners doing business in states that have enacted entity level taxes is a distinct possibility.
This possibility was recently highlighted by Bloomberg Tax’s Mina Capouet regarding the Goggin v. State Tax Assessor decision in Maine. Because Maine only allows a credit for income taxes paid by its residents to another state, the individual taxpayers in the case were denied a credit against their Maine income tax for New Hampshire business taxes paid by a limited liability company of which they were members. As New Hampshire does not follow the pass-through treatment of entities taxed as partnerships, the entity itself was liable for the Business Profits Tax and Business Enterprise Tax, which are not creditable under the Maine statute.
The decision highlights the inherent complexity of dual-level tax systems across such a complicated landscape of 50-plus state jurisdictions. At least 10 states impose some form of entity level tax on traditional PTEs, with a number of other industry or transaction-specific taxes in place, and, as discussed above, several more are considering them.
While combating tax base erosion brought by the shift from corporate entities to pass-through entities has been the traditional motive for states in enacting PTE level taxes, the SALT cap workaround potentially adds yet another issue to consider. Given the seismic shift in tax policy at the federal level, it is understandable that states, in scrambling to respond to that shift, are doing so in different ways. However, further fragmentation of state tax systems only serves to make it more difficult for taxpayers and practitioners to understand and predict tax liabilities across multiple jurisdictions.
Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn: Do the benefits of alleviating the impact of the SALT deduction cap justify the introduction of new taxes on PTEs? Why or why not?
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