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By Che Odom
Individual owners of partnerships could benefit indirectly under the House Republican’s tax plan that largely ends a federal deduction of state and local taxes for individuals.
Under the House tax-reform bill (H.R.1), which was last amended Nov. 9 by Ways and Means Committee Chairman Kevin Brady (R-Texas), individuals would only be able to claim the state and local deduction for property taxes up to $10,000 a year. Currently, the federal code allows people to deduct the cost of sales, income, and property taxes paid to state and local governments (SALT deduction).
However, the tax bill preserves the full state and local tax (SALT) deduction for corporations and passthrough entities.
Brady clarified the House GOP tax bill’s position on the issue in a Nov. 9 letter to House Ways and Means Committee member Earl Blumenauer (D-Ore.).
“Taxes imposed on and paid by a pass-through business, such as sales taxes and certain property taxes, would continue to be deductible by the business, to the extent related to business property,” Brady said in the letter. “State and local income taxes paid by an individual owner of such a business would not be deductible on the individual’s tax return.”
In passthrough entities, owners are taxed individually on the income, taking into account their share of the profits and losses. At the state level, the issue is complicated by how states treat passthrough entities, such as partnerships, S corporations, limited liability companies, and certain trusts.
For those states that piggyback onto the Internal Revenue Code’s definition of adjusted gross income or taxable income as their starting point, “limiting the deduction for state income taxes at the federal level may also directly or indirectly limit the deduction in many states,” Bruce Ely, senior partner in the Birmingham, Ala., office of Bradley Arant Boult Cummings LLP, told Bloomberg Tax.
The Senate Finance Committee released policy highlights of its tax proposal Nov. 9, but hadn’t released a more detailed summary at press time. A committee aide said the Senate plan would fully repeal individuals’ ability to write off their property taxes as well as their state and local income taxes—but it isn’t clear whether corporations and passthrough entities would be allowed the full deduction.
A handful of jurisdictions, such as Washington, D.C., tax the passthrough entity directly, Cathie Stanton, partner and national leader of state and local tax services at Cherry Bekaert LLP, told Bloomberg Tax.
“Since the income tax is imposed on the entity itself, and not the owners, it appears those amounts will remain deductible by the entity,” Stanton said, discussing the House plan. That might allow individual owners to benefit.
However, allowing the deduction at the passthrough entity level, “if this is the end result, while disallowing it at the owner level, could also create some screwy basis issues for the owners,” Ely said, expressing his personal views and not those of his law firm or an American Bar Association State and Local Tax Committee task force that he co-chairs. “We’re still puzzling through that one,” he added.
But in some states, individuals who own passthrough entities could be hurt by the change in federal tax law, Stanton said.
Many states allow certain itemized deductions for individuals, but most don’t allow a deduction for income taxes. “These states shouldn’t be impacted,” Stanton said.
“If a state does allow income tax expense, and ties it to the amount deducted for federal purposes, that may result in a higher state tax liability and additional revenue for the state,” she said.
State and local tax deductions have become a flashpoint in the debate over the GOP’s planned tax-overhaul legislation. Some Republican House members in high-tax states, including New York, New Jersey and California, have said the House bill would hurt their constituents.
(For the House’s initial version of the Tax Cuts and Jobs Act (H.R. 1), read http://src.bna.com/tVu. For a Nov. 6 amendment updating the bill, read http://src.bna.com/t1K. For a Nov. 9 amendment updating the bill, read http://src.bna.com/t76. For policy highlights of the Senate’s version of the bill, read http://src.bna.com/t8T.)
To contact the reporter on this story: Che Odom in Washington at COdom@bna.com
To contact the editor responsible for this story: Cheryl Saenz at firstname.lastname@example.org
Copyright © 2017 Tax Management Inc. All Rights Reserved.
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