The IRS on November 9 issued Notice 2020-75, informing taxpayers of forthcoming proposed regulations designed to clarify that state and local income taxes imposed on, and paid by, a partnership or an S corporation on its income are allowed as a deduction in computing the entity’s non-separately stated taxable income or loss for the tax year of payment. Under the regulations, partnerships and S corporations could deduct state and local income taxes against ordinary income, with no addback required at the individual partner or shareholder level.
The regulations are proposed to apply to Specified Income Tax Payments made on or after November 9, 2020. As described below, taxpayers may apply the proposed rules to payments made in entity tax years ending after December 31, 2017.
In light of the SALT deduction limitation enacted in the 2017 tax reform legislation, entity-level taxes have been adopted as a ‘workaround’ in Connecticut, Louisiana, Maryland, New Jersey, Oklahoma, Rhode Island, and Wisconsin. The Notice is an indication of the IRS position on these arrangements, including allowing reliance on the Notice itself, pending the regulatory process. As a result, additional states may consider enacting such taxes in upcoming legislative sessions.
The Notice is welcome news for partnerships and S corporations that have opted into state tax ‘workarounds’ with respect to the SALT deduction limitation. Pass-through entities that have not opted into state entity-level taxes -- of the post-TCJA adopting state regimes, only Connecticut’s is mandatory -- may wish to reconsider that position in light of this Notice.
Partner, PwC US
Private Company Services Tax Leader, PwC US
National Tax Services Market Leader and Mergers and Acquisitions Tax Leader, PwC US