In some cases you can deduct your state and local business taxes on your Federal return but not always. There is a catch. At the moment the most you can deduct on your Federal return is $10,000. There is also a catch to the catch; there is a way to deduct more. This depends on the type of business and the state where you reside.
At the moment dozens of states allow “pass through entities”. Basically a pass-through (also called a flow-through) entity is one where all the income goes directly to owners and investors. The business pays a Pass-Through Elective Tax (PTET) and that payment is a fully deductible business expense. Sometimes this is called SALT CAP workaround.
Paying this elective tax is voluntary. Some might ask’; why pay a voluntary tax? The reason is that the ultimate deduction can be worth more than what you pay. Paying a PTET keeps you from being taxed twice on earnings and allows you to deduct your state tax payments at the same time. As noted, you cannot take advantage of this way of paying your business tax in every state but you can in over 30 states. The laws from state to state are different and there are Federal criteria that must be met.
In general pass-through entities have to be legal businesses, be taxed at the owner’s individual tax rate , pay no corporate tax and must be particular types of businesses (LLCs, S corporations, sole proprietorships or partnerships). As stated there are variations by state and consulting a tax professional is advisable.
One of the states allowing businesses to pay a PTET is California. In California a qualified taxpayer is a shareholder, partner or member that is also an “individual, fiduciary, estate or trust subject to California personal income tax or a disregarded single member LLC owned by the same”.
In California businesses that do not qualify include publicly traded partnerships and entities permitted or required to be in a combined reporting group. A combined reporting group is a group of corporations or other business entities that file a combined return.
There has been some concern in the House of Representatives over the $10,000 deduction limit. Noise has been made about helping businesses from this limit but it may just be noise. Actual change may be difficult to achieve in the near future.
Paying the pass through entity tax can save your business significant money. Hito is here to help your company take.