The Tax Cuts and Jobs Act of 2017 (TCJA) imposed a $10,000 cap on the federal deduction for state and local taxes for tax years 2018-2025. While corporations are not subject to the cap, business owners who pay state and local income tax on pass-through income are subject to the cap.
On November 9, 2019 the IRS released Notice 2020-75 indicating it would issue regulations to clarify that state and local taxes paid by a partnership or corporation would be deductible by the partnership or S corporation when they compute their pass-through income. This guidance paves the way for states to enact legislation that imposes taxes on pass-through income at the entity level instead of the individual owner level and thereby avoids the $10,000 cap on the state and local tax deduction (the “SALT workaround.”)
A bill has now been introduced in the South Carolina General Assembly, H 3978, to allow South Carolina taxpayers to take advantage of the SALT workaround. Under the bill, a partnership or S corporation (including limited liability companies taxed as such) can make an annual election to have income tax on its active trade or business income imposed on the pass-through entity itself. If an entity makes the election, the entity owners then exclude the trade or business income the entity paid tax on from their income. Since the entity owners do not include the trade or business income in their individual income, they do not pay state and local tax on such income and avoid the $10,000 cap.
The bill is in the early stages of the legislative process but would be a welcome relief for South Carolina taxpayers, and will not impact the tax revenues collected by South Carolina. If passed, the bill would apply to tax years beginning after 2020.