Articles

Maryland's SALT Deduction Cap Workaround

Date: June 24, 2020
The 2017 tax law, known as the Tax Cuts and Jobs Act (the “TCJA”), imposed a $10,000 limit on individual state and local tax (“SALT”) deductions, but not on entity taxpayers. This deduction has been a particular pain point for owners of pass-through entities (“PTEs”) that pay state and local taxes to high-tax states. These potential deductions pass through to the individual owners, who are subject to the $10,000 SALT cap.

To side step this issue, several states, including Maryland, have enacted legislation imposing a pass-through tax directly on the entity, to be paid by the PTE itself, thereby side-stepping the SALT cap in the TCJA.

Under Maryland’s legislation (S.B. 523), effective for tax years beginning after December 31, 2019, Maryland PTEs will be able to elect to have the entity pay Maryland state income tax instead of the tax being paid by the entity owner(s). The goal is to allow for an entity level federal SALT deduction that is not subject to the TCJA SALT cap.

The PTE will pay a tax rate equal to the top marginal Maryland rate for individuals, plus the lowest applicable county tax rate (which is the same rate charged to nonresident members of Maryland PTEs) or the Maryland corporate tax rate for corporate owners of a PTE. PTE members are still required to report their PTE income on their federal and Maryland return; however, they could take a credit on their Maryland return for taxes paid by the PTE on their allocable share of PTE income. If the PTE owner’s local tax rate is higher than the applicable county tax rate used by the PTE, the owner would be responsible for paying the difference in tax with their individual return. Consequently, Maryland expects no revenue reduction under this new regime.

The new legislation also provides that income allocable to tax-exempt owners and REIT owners of a PTE will not be taxed under this election. Further, an owner of a PTE that is itself a PTE will not be eligible for having their income taxed at the lower tier PTE level and will need to make their own election.

The tax due under this new law is capped at the distributable cash flow of the PTE, defined at TG §10-102.1(a). It also appears that, if the PTE does not pay the tax due after making this election, Maryland can seek collection from the PTE members.

One area that has not been specifically addressed is the treatment of sole proprietorships and disregarded entities. Without definitive guidance, small companies and real estate owners may decide to reorganize their business into partnerships or S-Corporations to take advantage of this new statute.
The information contained here is not intended to provide legal advice or opinion and should not be acted upon without consulting an attorney. Counsel should not be selected based on advertising materials, and we recommend that you conduct further investigation when seeking legal representation.