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Illinois trumps SALT cap

On Aug. 27, 2021, Gov. Pritzker signed into law a state and local tax (SALT) cap workaround. In Dec. 2017, Congress passed the Tax Cuts and Jobs Act of 2017, which generally reduced tax rates for individuals and businesses. However, the Act also placed an annual $10,000 cap on an individual’s deduction for state and local taxes. The cap on state and local taxes was seen as a move by former President Trump to punish Democratic leaning states such as California, New York and Illinois — all of which have relatively high state and local tax burdens.

Businesses, such as partnerships and S corporations, generally do not pay tax at the entity level. Rather, the entity income flows through to the respective owners and the owners report the income on their individual tax returns. Due to the SALT cap, owners have been unable to fully deduct the Illinois taxes paid on entity income on their federal returns.  

While the SALT cap limits an individual’s ability to deduct state and local taxes, there is no similar provision limiting the ability of an entity to deduct state and local taxes. The new Illinois law exposes this loophole by having the entity pay the Illinois tax rather than the individual. The new Illinois law, effective for tax years ending on or after Dec. 31, 2021, permits a partnership or S corporation to elect to pay Illinois taxes at the 4.95% individual tax rate. These Illinois taxes would be then deducted by the entity on its federal tax return. Each owner of the entity can then claim a credit on his or her individual Illinois income tax return equal to 4.95% of the owner’s share of the entity’s income. 

In Notice 2020-75, the IRS confirmed that this workaround strategy succeeds in bypassing the SALT cap. This workaround strategy may not be suitable for every partnership and S corporation, such as those with non-Illinois owners. Yet, the workaround will restore a full federal deduction on state taxes for many business owners.

Please contact an attorney from Chuhak & Tecson to determine if the Illinois entity election can reduce taxes for your business. 

Client alert authored by David B. Shiner (312 855 4319), Principal and leader of Chuhak & Tecson's Tax & Employee Benefits group.

This Chuhak & Tecson, P.C. communication is intended only to provide information regarding developments in the law and information of general interest. It is not intended to constitute advice regarding legal problems and should not be relied upon as such.
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