Massachusetts Joins Rhode Island In A Mostly Successful Attempt To Work Around The Federal $10,000 Itemized Deduction (SALT) Limitation.

William Delaney, EA
Westwood, MA

Under RI Gen. Laws §44-11-2.3, a pass through entity (S corporation; partnership), is permitted to make an annual election “by filing the prescribed tax form and remitting the appropriate tax.” [§(a)(1)] “…to pay the state tax at the entity level…” [§(a)(5)(b)(1)] A proportionate credit for state tax paid shall be allowed on the owner’s RI personal income tax return [(a)(5)(d)]. Effective 7/1/2019.

§(a)(4) defines a pass-through entity as “…a corporation that…is treated as an S corporation…, or a general partnership, limited partnership, limited liability partnership, a member of a limited liability company, a beneficiary of a trust, or a sole proprietor.”

This is a far more expansive definition than its MA counterpart found in Section 1 of the MA legislation (see below), and it appears to exceed the relied upon authority found in IRS Notice 2020-75 (see page 2), which limits the concept to “…taxes imposed on and paid by a partnership or an S corporation on its income.” (editor’s commentary).

The current MA state budget (enacted 7/16/2021) adds new Chapter 63D to the Taxation of Pass-Through Entities (Chapter 63) of MGL. An “eligible pass-through entity” is defined as an S corporation; a partnership; an LLC which elects S corporation taxation [Section 1]. See also comments (above) regarding the comparable RI language which defines a pass-through entity.

“An eligible pass-through entity may elect to pay an excise on its qualified income taxable in Massachusetts at a rate of 5 per cent. A qualified member (defined as a shareholder of an S corporation or a partner in a partnership) of an electing pass-through entity shall be allowed a refundable tax credit computed proportionately but limited to 90% of the amount apportioned. The credit may only be claimed for the tax year in which the eligible pass-through entity’s taxable year ends (usually a calendar year) [Section 2]. RI does not reduce the apportioned credit amount.

The election is to be made on an annual basis, “…in a manner determined by the commissioner…” and “…shall not be revoked.” It applies to all members of the entity. [Section 6]. If the SALT limitation is subsequently repealed, the tax credit will no longer apply [Section 3].

The applicable federal concept is that this taxation scheme qualifies under federal law as a tax imposed on income which is an allowable federal deduction (state income tax expense) against pass-through income (but see commentary on page 1 regarding the expansive RI definition of a pass-through entity). The deduction is added back to pass-through income for purposes of both RI and MA personal income taxation. Authority is IRS Notice 2020-75 effective November 9, 2020, which states that the IRS “…intend(s) to issue proposed regulations…”. Specifically, as authority used by both RI and MA…

SECTION 3. FORTHCOMING PROPOSED REGULATIONS

.01 Purpose and scope. “…the forthcoming proposed regulations will clarify that Specified Income Tax Payments (as defined in section 3.02(1) of this notice) are deductible by partnerships and S corporations in computing their non-separately stated income or loss.”

.02(1) “…the term Specified Income Tax Payment means any amount paid by a partnership or an S corporation to a State, a political subdivision of a State…(Domestic Jurisdiction) to satisfy its liability for income taxes imposed by the Domestic Jurisdiction on the partnership or the S corporation.” Apparently, it does not matter that the tax is self-imposed by election and not uniformly imposed by statute (editor’s commentary).

.02(2) “…the partnership or S corporation is allowed a deduction for the Specified Income Tax Payment in computing its (federal) income for the taxable year in which the payment is made.”

.02(4) “Any Specified Income Tax Payment…is not taken into account in applying the SALT deduction limitation to any individual who is a partner in the partnership or a shareholder of the S corporation.” This is the work-around the $10,000 limitation because the specified income tax payment is outside of the limitation (not taken into account) when claiming itemized deductions (editor’s commentary).