Proposed SALT Deduction Cap Creates Disparate Impacts for Passthrough Entities

As Congress works to pass proposed tax legislation cited as the “One Big Beautiful Bill Act,” State and Local Tax (“SALT”) deductions remain a sticking point. The current draft is especially concerning for partners and S corporation shareholders because it would continue to limit SALT deductions at the individual level (capped at $10,000 per taxpayer) and disallow an IRS-approved work-around deduction for most SALT taxes for partnerships and S corporations. If the work-around is eliminated, partnerships and S corporations would be required to pass through state and local taxes to their partners and shareholders as separate line items, making them subject to the individual SALT deduction cap.

The proposed bill includes a few limited exceptions to the disallowance of SALT deductions at the entity level, including for:

• Foreign taxes.
• Property taxes paid or accrued with carrying on a trade or business.
• State, local, and foreign taxes paid by businesses that are “qualified entities” under Sec.199A. That section of the Internal Revenue Code allows many businesses to reduce their federal taxable income by 20%. The legislation indicates that a qualified entity cannot be a “specified service trade or business,” which means that most professional service and consulting firms would not be able to deduct SALT taxes without limit at the entity level.

Tax experts and industry associations have sounded alarms about the disparate tax treatment of the bill, whereby partners and S corporation shareholders of service-based businesses have materially worse tax consequences than most other businesses.

On May 15, the S-Corporation Association of America called on Republicans to drop the proposed SALT deduction limitations for pass-throughs, saying that the “provisions are hopelessly complicated and will hurt members of the very Main Street business community this bill is supposed to help.” The American Institute of CPAs has said the bill “would indirectly increase taxes on millions of service-based businesses and expand the disparity in how the tax code treats C corporations versus pass-through entities.” And tax experts have also raised concerns about the bill’s failure to address sales taxes among the excepted taxes for which the deduction cap applies.

Final details regarding changes to SALT deductions remain in flux. After initially rejecting the bill on May 16, the House Budget Committee narrowly voted to pass the bill after a revote on May 18. With several House Republicans withholding their support for the bill as approved by the Budget Committee, on May 20, Speaker Mike Johnson offered to set the SALT deduction cap at $40,000 for anyone making less than $751,600 a year; the deduction would be $20,000 for individuals making more than $80,000 and $10,000 for individuals making more than $850,000.

LP’s tax attorneys continue to monitor the ever-evolving legislation. If you have any questions, please reach out to a member of our Tax Planning Group.