Salt Cap Workaround: Legislative Updates in 2023

SALT cap workarounds have been an evolving topic in the tax field in recent years, with many states introducing Pass-Through Entity Taxes (PTETs) that benefit business owners. However, these SALT cap workarounds vary from state to state and eligibility requirements continue to evolve and change. 

In 2023, several states amended their existing PTET legislation, while others have just passed legislation enacting PTET. Some have enacted this tax from the 2023 tax year forward, while others backdated changes to previous tax years, allowing business owners to retroactively amend their tax filings. 

This is a fast-evolving field: one that can have a significant impact on a business owner’s overall tax exposure. In this update, we provide an overview of how SALT cap workarounds have changed in recent years and highlight three states that have introduced notable PTET changes in 2023. 

The SALT Cap Workaround: A Brief Overview

Among the many changes to tax law ushered in by the 2017 Tax Cuts and Jobs Act was a $10,000 limit to state and local tax deductions. This limit, commonly referred to as the SALT cap, negatively impacted many business owners that itemized their deductions on their tax returns, capping the value of these deductions at $10,000. Previously, there was no limit to the state and local taxes that taxpayers could itemize and deduct. 

In response, many states, beginning with high-cost-of-living states such as California and New York, pioneered alternative approaches to alleviate the burden on taxpayers. Early efforts were rejected by the IRS, but in 2020, the IRS blessed one form of workaround: a pass-through entity tax. 

Recent years have seen many states adopt their own version of a pass-through entity tax, which allows business owners to elect to pay and deduct state income taxes at the entity level, rather than the individual level. Since this legislation is made at the state level, it varies from state to state, and states continue to introduce new or updated legislation. 

New SALT Cap Workaround Legislation To Be Aware Of

2023 has been a notable year for the SALT cap workaround, with several states introducing new or updated legislation that affects PTET eligibility. The most significant changes have occurred in Georgia, North Carolina, and Connecticut.

Georgia: House Bill 412 Expands Eligibility

Georgia’s original pass-through entity tax, effective for tax years beginning on or after January 1, 2022, only permitted S corporations and partnerships that were wholly owned by persons eligible to be shareholders of an S corporation (individuals, estates, and some trusts) to make the pass-through entity tax election. 

House Bill 412, signed into law in May 2023, modified this for tax years beginning on or after January 1, 2023, eliminating this eligibility requirement and enabling more partnerships to elect into the pass-through entity tax. 

North Carolina Modifies Eligibility Requirements

Like Georgia, North Carolina also modified their eligibility requirements in 2023. However, unlike Georgia, North Carolina backdated these changes to apply for tax years beginning on or after January 1, 2022. Before these changes, a partnership could not elect to pay pass-through entity taxes if it had a partner who was not an individual, trust, or estate. 

Session Law 2023-12 changed this, allowing partnerships with partners including other partnerships or S corporations to make this election, although partnerships with C corporation owners remain ineligible. Taxpayers who have already filed for 2022 are eligible to amend their filing to make the election. This must be completed by the extended due date of the tax return. 

The law also mandated other changes, including changes to the calculation of the PTE tax base.

Connecticut Changes from a Mandatory to an Optional PTET Election

Connecticut was the first state to enact a PTET, with initial legislation signed into law in 2018. Today, Connecticut is the only state where the PTET is currently mandatory, but that’s set to change from the 2024 tax year onwards. 

House Bill 6941, signed into law in June of 2023, modifies the existing law, making the PTET an optional election rather than a mandatory one for tax years beginning on or after January 1, 2024. Pass-through entity owners should consult with their tax advisors to determine whether it would be beneficial to elect into PTET from 2024 onward. 

The State of Play with SALT Cap Workaround Legislation

SALT cap workarounds continue to change and evolve across many states, with seven states passing legislation enacting a PTET this year:

• Hawaii and Montana – effective for tax years beginning on or after January 1, 2023.

• Indiana, Iowa, Kentucky, and West Virginia – effective for tax years beginning on or after January 1, 2022.

• Nebraska – retroactive for tax years beginning on or after January 1, 2018.

Currently, 36 states and one locality have now enacted a pass-through entity tax. Three further states, Maine, Pennsylvania, and Vermont, currently have proposed PTET legislation progressing through the state legislatures. 

States without personal income taxes do not need a PTET and therefore are not considering any legislation. These states are Alaska, Florida, New Hampshire, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming. 

Only two states, Delaware and North Dakota, plus the District of Columbia, have owner-level personal income taxes and do not currently have a proposed or enacted PTET legislation. 

Key Factors for Taxpayers to Bear In Mind

Determining whether to make a PTET election is a complex issue and business owners should seek guidance from their tax advisors. With new states enacting PTET, and changes to existing PTET legislation, it is important to keep several key factors in mind:

• Timing of the Election: states have varying requirements on when the pass-through entity election must be made. In some states, the election must be made during the tax year; in others, it must be made within a certain time period after the end of the tax year. What constitutes an election also differs from state to state: it could be completing an online form, making a payment, or just checking a box on a tax filing.

• Estimated Tax Payments: it is important for taxpayers to be aware of required estimated tax payments in their state(s) to avoid underpayment penalties, and some states even require the estimated tax payments to be made in order to make a valid election for the tax year. 

• Cash Basis Taxpayer Considerations: cash basis taxpayers should aim to make estimated tax payments before the end of the tax year in order to take this deduction against the current year’s taxable income.

Smith + Howard: Experienced Tax Advisors

Pass-through entity taxes and the legislation that governs them is a complex, fast-moving field that varies significantly from state to state. For business owners, a tax advisor with the skills and experience to navigate these laws and build an effective tax strategy is a crucial long-term partner.

At Smith + Howard, we’re proud to serve as tax advisors to business owners all over the nation. Our team of experienced tax professionals brings a sophisticated approach to tax planning that combines business and personal tax strategies to build an optimal path forward for businesses and their owners. 
To learn more about Smith + Howard’s tax services, contact an advisor today.