The vast majority of businesses in the United States are pass-through entities, which means that profits go directly to the owners. Those businesses now have an opportunity to defer some of the manager's state income taxes because of this new shortcut.

Typically, the passing business pays for the fee. Some states offer tax deductions, while others offer tax credits. Everyone's situation is different. As a result, it's critical to provide specific figures.

There was a 9.3% tax imposed on select firms by California Gov Gavin Newsom last week, for example, which he signed into law. Owners who participate in the programme are eligible for a 9.3% tax credit on their Californian tax returns.

A Sacramento CPA and partner at Avaunt Ltd. CPAs & Consultants, Perry Ghilarducci, said, "You've already paid your state taxes on your pass-through revenue. As with anything else, there are exceptions to every rule. Businesses that pay several hundred thousand dollars in estate and state income taxes each year can find ways to avoid being penalised.

State and Local Tax (SALT) Deduction Limit

Previously, Schedule A's deduction for state and local taxes (SALT) was unrestricted. Inheriting these charges is:

• Real property taxes
• Personal property taxes
• Income taxes

General sales taxes

War profits and other items subject to excise and other taxes

An person is limited to a $10,000 deduction for state and local taxes paid in a year (or $5,000 if married filing separately) under the Tax Cuts and Jobs Act. Residents of states with high property and property tax rates may be disproportionately affected by the $10,000 limit.

Looking for Loopholes

Since the $10,000 threshold was imposed in 2017, states with high tax burdens have been exploring for ways to help their citizens avoid it. To allow residents to donate money to a state charity fund instead of paying taxes and deduct the payments from their federal tax returns as charitable contributions, several states, including New York, New Jersey, and Connecticut, presented legislation in 2019. The IRS and Treasury ultimately rejected the scheme.

According to the IRS, pass-through entities are a workaround, and states have been working on approving this for some time now.

What Is a Pass-Through Entity?

An entity that sends revenue to its owners and investors is referred to as "pass-through" or "flow-through." Taxes are not paid on the profits of pass-through firms, but rather on the individual tax rate of the owner. Avoiding double taxation is prevalent when using pass-through entities. Limits on SALT deductions may be increased by the IRS in the future (IRS).

Pass-through businesses, such as LLCs and S-corporations, have just received IRS approval for workarounds. The IRS has issued a notice stating that partnerships and S companies may deduct certain income tax payments when calculating non-separately reported income or loss.

To illustrate, let's say an LLC or S-corporation owes federal income taxes. This notice from the Internal Revenue Service includes any amount paid by a partnership or S corporation to a state, its political bodies, and the the District of Columbia to satisfy its income tax obligations.

Additionally, S corporations and partnership can deduct more than $10,000 from municipal governments' income tax payments for S corporations.

Taxes on pass-through entities are levied at the owner's level in the majority of countries. Taxes on businesses have been adopted, proposed, or are being considered by 13 states.

Pass-through state laws

Single-member LLCs and sole proprietorships are not affected by this workaround. A statement from Treasury Secretary Steven T. Mnuchin on November 9 stated that the Treasury and IRS are taking the necessary actions to ensure fairness for small companies in the United States. Individual pass-through entity owners will benefit from these proposed regulations. More states will likely come up with similar solutions if the IRS finalizes its standards.

The Bottom Line

As of November 9, 2020, the IRS has proposed new regulations that apply to certain income tax payments. Even though new rules have been issued, the IRS had stated that some taxpayers could amend their returns for partnership or S corporation income tax payments made after December 31, 2017, and before November 9, 2020—and the payment was "made to satisfy the liability for income tax imposed on the partnership or S corporation according to a law that was in effect before November 9, 2020," per a notice issued by the agency. A tax specialist can tell you whether or not you qualify for the workaround and whether or not to alter any prior returns.