A growing number of states are using a workaround to help their taxpayers avoid a Trump-era cap on a critical income tax break. Whether it will influence the ongoing push in Congress to repeal the cap altogether remains to be seen.
Colorado recently became the 14th state to enact the new workaround, which allows (or in Connecticut’s case, requires) pass-through businesses to pay state income taxes at the entity level rather than on their personal income tax returns. For small businesses like partnerships, declaring that income as a business instead of passing it through to their individual tax returns means the state taxes paid on that business income don’t count toward their SALT cap.
The new mechanism is called a pass-through entity (PTE) tax, which is exempt from the $10,000 cap on the state and local tax (SALT) deduction that was part of President Trump’s 2017 tax reform. For business owners in high property tax states like New Jersey and Connecticut, it’s a critical change because it allows those taxpayers to deduct more of their local taxes from their other personal income.
But it’s not just blue states that are employing the tactic — red states make up half of the states that have adopted it.
States are forging ahead with these workarounds even as bipartisan support in Congress for dropping the cap altogether is growing. On Wednesday, Rep. Thomas Suozzi (D-N.Y.) joined colleagues as well as local officials from New York, Ohio and the National League of Cities to report on their progress toward a repeal.
“This is going to be another three months of negotiation,” Suozzi said. “It’s not going to happen tomorrow or the next day. But we are continually getting more people the House floor to say, ‘No SALT, no deal.”
On that call, Rep. Young Kim (R-Calif.) pointed out that setting a limit on the deductibility of state and local taxes across 50 states with very diverse economies and tax policy puts states like hers at a disadvantage. In coastal California, median incomes top six figures and the cost of housing is much higher than the rest of the United States. It means that by default, Californians pay nominally more in state income and local property taxes than many other places.
“You can’t compare the median $800,000 home price here to the median home price in Oklahoma, for example,” she said. “Comparing California to others…and saying a $10,000 cap is good for everyone doesn’t work.”
California is one of four states considering the new SALT tax workaround.
Meanwhile, observers note that creating the workaround may help even the playing field for some taxpayers compared with their counterparts in other states — but it adds to inequities within a state by favoring-pass through income over wages.
For example, notes the Tax Policy Center’s Kim Rueben, a partner in a law firm can be effectively exempt from the SALT cap while an executive assistant or associate in the same firm remains subject to the deduction limitation.
But she predicts the workaround will continue to catch on.
“While it makes state taxes more complicated, it helps residents reduce federal taxes at no cost to the states themselves,” she wrote. “What a deal.”