As 2021 ends, Congress discusses raising the $10,000 cap on the state and local tax (SALT) deduction. Regardless of the outcome of new legislation, some high-income business owners, with tax-savvy advisors, are already legally skirting the current cap. Here is how.
Business concept of taxes planning 2022. Businessman turns wooden cube and changes words ‘Taxes 2021’ to ‘Taxes 2022′. Beautiful white background, copy space. Business, 2022 taxes concept. Approximately 20 states, including New York, California, Connecticut, New Jersey, and Illinois, have implemented forms of a SALT workaround thus far. Pass-through businesses, such as partnerships and S corporations, often do not pay taxes; instead, revenues are passed through to their owners, who report income on their tax returns. As a result, they are subject to state income taxes and the federal deductibility limit of $10,000 imposed under the 2017 tax law.
While each state tax legislation relating to this strategy has its idiosyncrasies, the SALT workaround flips the concept by giving a mechanism to boost deductions relevant to the federal tax return that are not subject to the SALT limits. The states collect – often optionally – taxes on pass-through businesses that are like their owners’ state income taxes. These taxes are then deducted before distributing the money to the business owners.
The laws then use tax credits or other means to relieve business owners of income-tax responsibilities resulting from business profits. As a result, they satisfy state income tax liabilities while avoiding individual state income tax deductions subject to the federal cap.
This strategy can benefit business owners who have such pass-through businesses because every $100,000 of nondeductible state taxes converted to deductible state taxes results in a net gain of up to $37,000 on federal income tax returns. The federal government loses tax money because of this strategy, while states keep such taxpayers in their states rather than going to states with lower tax rates.
Nonetheless, legislation passed by the House (which still must be approved by the Senate) to raise the threshold from $10,000 to $80,000 would eliminate the need for many business owners to adopt this odd SALT workaround strategy.
Because the workarounds can lower adjusted gross income, they may also provide a way to offset state taxes from the new surtaxes imposed on persons earning more than $10 million and $25 million. These workarounds may reverse what the current House majority leadership wants by shielding the wealthiest corporations from further levies under the proposed package. This is precisely why and how tax laws get so complex.
While the Treasury Department prohibited other workarounds, they permitted some and promised further details in future legislation. Some organizations may be hesitant due to a lack of complete clarity, and solutions can be complicated. Janiczek Wealth Management’s tax planning services, delivered through our Complete Wealth SolutionTM in partnership with a client’s tax preparers, CPAs, and tax attorneys, are designed to bring such lawful approaches to decrease taxes to the client’s attention in precise and proactive ways. Unfortunately, many taxpayers are imprecise and reactionary in tax preparation, which we feel is a frequent and costly mistake.
For more information on Janiczek Wealth Management, go to www.janiczek.com or call Cathy Wegner at 303-339-4480 (or email cwegner@janiczek.com), Director of New Client Engagements, to begin a conversation with us to see how we may be of service to you for all of your portfolio management, wealth management, tax planning, and retirement planning and management needs.
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