In May, Maryland became the seventh state to implement a new business tax option to help Maryland business owners avoid new limits on state and local tax (SALT) deductions. Before 2018, tax law permitted individual taxpayers to deduct taxes paid to states and municipalities on federal income tax returns. These SALT deductions allowed taxpayers in states with higher income or property taxes like California, New York, New Jersey, and Maryland to mitigate state and local taxes through a reduced federal tax obligation.
SALT Deduction Caps
The Tax Cuts and Jobs Act, which went into effect in 2018, capped SALT deductions for individual taxpayers at $10,000. The cap most impacted taxpayers who live in the states with higher state taxes. In Maryland, more than 500,000 residents lost more than $6.5 billion in SALT deductions. As a result, many states have pushed back against SALT deduction limitations, passing legislation to avoid these caps.
On May 7, 2020, Maryland implemented its SALT deduction cap workaround when Governor Larry Hogan allowed Senate Bill 523 to become law without his signature. The new law went into effect on July 1, 2020, creating an elective federal and SALT deduction cap workaround for pass-through entities (PTEs). The workaround will apply to all tax years beginning December 31, 2020.
The new law will allow pass-through entities (PTEs) with Maryland-source income to subject their Maryland taxable income to state and local taxes at the business entity level. In other words, Maryland and Maryland municipalities will tax the pass-through business entity rather than the individuals that receive the business's pass-through income. Under current federal income tax law, PTEs can still deduct all state and local taxes paid. Allowing the PTE to pay these state and local taxes, rather than subjecting individual taxpayers to the taxes, will neatly circumvent the federal government's $10,000 SALT deduction cap.
Will This Workaround Hold Up?
Maryland's new law isn't the state's first attempt to bypass the SALT deductions cap. In an early response to the Tax Cuts and Jobs Act, Maryland and several other states passed legislation allowing municipalities to create charitable funds where taxpayers could donate in exchange for a property tax credit. The Internal Revenue Service announced that states could not bypass the cap on SALT deductions, and, in response, Maryland joined other northeast states in a lawsuit seeking to strike down the cap. The lawsuit argued that the cap targeted high-tax states and unconstitutionally interfered with states' ability to make fiscal decisions. U.S. District Judge J. Paul Oetkin dismissed the states' lawsuit in October of 2019, leaving the fate of future SALT cap workarounds like SB 523 up in the air. As a result, it's a good idea to discuss the probable consequences of this new legislation with your Maryland tax attorney.
Contact Gabaie & Associates, LLC for a free consultation about your federal or Maryland tax filings. We have convenient offices located throughout Maryland, in Annapolis, Baltimore, Columbia, Frederick and Rockville. Call us at (410) 862-2198 if you have questions about how the new Maryland law may affect your personal or business tax obligations.