Here’s what HIVE AI had to say about “Are there changes to the pass-through entity tax workaround for SALT under the One Big Beautiful Bill?”:
Pass-Through Entity Tax Workaround for SALT Under the One Big Beautiful Bill
The One Big Beautiful Bill does not appear to contain specific provisions that directly modify the existing pass-through entity tax workaround for State and Local Tax (SALT) deductions. However, understanding the current framework and how the bill’s SALT cap changes might interact with pass-through entity structures requires a comprehensive analysis of both the existing workaround mechanisms and the proposed modifications.
Current Pass-Through Entity SALT Workaround Framework
In enacting section 164(b)(6), Congress provided that “taxes imposed at the entity level, such as a business tax imposed on pass-through entities, that are reflected in a partner’s or S corporation shareholder’s distributive or pro-rata share of income or loss on a Schedule K-1 (or similar form), will continue to reduce such partner’s or shareholder’s distributive or pro-rata share of income as under present law.” This provision established the foundation for what became known as the pass-through entity tax workaround, where states could impose entity-level taxes on pass-through entities that would not be subject to the federal SALT deduction limitation.
The workaround operates by allowing states to impose taxes directly on pass-through entities rather than on the individual owners. Since these entity-level taxes reduce the income that flows through to the individual partners or shareholders, they effectively provide a deduction at the entity level that bypasses the individual SALT cap limitation. The individual owners then receive a corresponding credit against their state income taxes, creating a mechanism to circumvent the federal SALT deduction limitation.
Interaction with the Enhanced SALT Cap
The One Big Beautiful Bill implements a $40,000 SALT Cap (2025-2029) with a 30% Phasedown to $10,000 SALT Cap Over $500K Income, $10,000 SALT Cap from 2030 Onward Tax Foundation , which significantly increases the available SALT deduction for most taxpayers during the temporary period. This enhancement may reduce the relative attractiveness of the pass-through entity workaround for many taxpayers, particularly those whose state and local tax burden falls below the new $40,000 threshold.
For taxpayers with state and local tax obligations exceeding $40,000, the pass-through entity workaround may continue to provide value, especially for those with incomes below the $500,000 phaseout threshold. However, for taxpayers subject to the phaseout mechanism, the interaction between the reduced SALT cap and the pass-through entity workaround becomes more complex, requiring careful analysis of the combined benefits.
Technical Considerations for Pass-Through Entities
The determination of tax treatment at the pass-through entity level involves complex regulatory frameworks. The determination of whether there is a substantial or gross valuation misstatement in the case of a return of a pass-through entity (as defined in § 1.6662-4(f)(5)) is made at the entity level. However, the dollar limitation ($5,000 or $10,000, as the case may be) is applied at the taxpayer level (i.e., with respect to the return of the shareholder, partner, beneficiary, or holder of a residual interest in a REMIC). Treasury Reg. Treasury Regulation 1.6662-5
This entity-level versus taxpayer-level distinction becomes particularly important when considering how the enhanced SALT cap under the One Big Beautiful Bill might interact with existing pass-through entity structures. The entity-level determination of certain tax attributes, combined with taxpayer-level limitations, creates a framework that must be carefully navigated when implementing tax planning strategies.
State-Level Implementation Considerations
The effectiveness of pass-through entity SALT workarounds depends heavily on state-level implementation and compliance with federal requirements. States that have implemented these workarounds have generally structured them to ensure that the entity-level taxes qualify as business expenses that reduce the income flowing through to individual owners, rather than as taxes subject to the individual SALT deduction limitation.
The temporary nature of the enhanced SALT cap under the One Big Beautiful Bill may influence state policy decisions regarding these workarounds. States may need to evaluate whether to maintain, modify, or sunset their pass-through entity tax provisions based on the changing federal landscape and the needs of their taxpayers.
Planning Implications During the Transition Period
The five-year period during which the enhanced $40,000 SALT cap is in effect (2025-2029) creates unique planning opportunities and challenges for pass-through entity structures. Taxpayers and their advisors must consider whether the enhanced federal SALT deduction reduces the need for state-level workarounds, particularly for those with moderate state and local tax burdens.
For high-income taxpayers subject to the phaseout mechanism, the interaction between the reduced federal SALT cap and state-level pass-through entity taxes requires sophisticated modeling to determine the optimal tax structure. The temporary nature of the enhanced cap also necessitates long-term planning for the reversion to the $10,000 cap in 2030.
Compliance and Administrative Considerations
The determination of whether a taxpayer acted with reasonable cause and in good faith with respect to an underpayment that is related to an item reflected on the return of a pass-through entity is made on the basis of all pertinent facts and circumstances, including the taxpayer’s own actions, as well as the actions of the pass-through entity. Treasury Reg. Treasury Regulation 1.6664-4 This standard emphasizes the importance of proper documentation and compliance procedures when implementing pass-through entity tax strategies.
The enhanced scrutiny of pass-through entities by tax authorities, as evidenced by the IRS announcement of the new pass-through field operations unit in its Large Business and International (LB&I) division to more efficiently conduct audits of pass-through entities, reflecting the IRS’s broader efforts to focus more attention and resources on an area that has historically been under-scrutinized IRS Newsroom – IR-2024-276 , underscores the importance of maintaining robust compliance procedures for any pass-through entity tax planning strategies.
Future Legislative Considerations
While the One Big Beautiful Bill does not explicitly modify the pass-through entity SALT workaround, the enhanced SALT cap and its eventual reversion create a dynamic environment that may influence future legislative action. Policymakers may need to address the interaction between federal SALT limitations and state-level workarounds as part of broader tax reform efforts.
The temporary nature of the enhanced SALT cap also creates uncertainty that may affect the long-term viability and attractiveness of pass-through entity workarounds. Taxpayers and states may need to prepare for potential changes to these structures as the federal tax landscape continues to evolve.
Sources
- Tax Foundation – Big Beautiful Bill Senate GOP Tax Plan
- IRS Internal Revenue Bulletin 2020-49
- Treasury Regulation 1.6662-5
- Treasury Regulation 1.6664-4
- IRS Newsroom – IR-2024-276
Try Your AI Tax Assistant for Free!
Ready to transform your practice with agentic AI in tax? See firsthand how our cutting-edge AI tax tools can revolutionize your approach to tax research and planning.