New York Adapts SALT Cap Workaround | The Stoler Report-New York's Business Report
♪ [Theme Music] ♪ ♪ [Theme Music] ♪ >>> Michael: What is this SALT, changes to law? What's going on? Who knows the answers to this, you know, $10,000 deduction? I don't, I don't know this rule. And new rules. What's, what's really taking place? So today I've assembled from California and from Philadelphia, two leading tax per-- professionals to provide their insight on the adaption of the SALT cap workaround and new invaluable tax breaks for residents and owners of business and operations in New York and other states. My guest from Southern California, we have bright eyed and bushy tailed Christian Burgos, who is the managing principal co-leader for the state and local tax at Friedman, LLP. And from the city of brotherly love. Okay? We have Jay Brower, who is the partner and this state and local tax leader at Marks Paneth, LLP. So, we got you up early Christian this morning. Why don't you explain to my audience, what was the tax, the SALT, in 2017, which everybody's pissed off, especially if you're from New York or from California, because it limited to $10,000? Explain the SALT.
>>> Christian: Absolutely. So, prior to the tax reform, tac-- individual taxpayers were allowed to take a deduction for any state and local taxes paid, which included any state income taxes, property taxes, and even to a certain extent sales taxes. And with the passage of the tax reform act, the -- the state and local tax deduction was actually kept to $10,000. Now that impacted a lot of the states, like California and New York and other high income tax states, where we are overly taxed. I
mean, from an income tax perspective, we pay significant amount of property taxes as well. And for a lot of high income -- income taxpayers that actually created an instance where we now saw an increase in our individual tax bills for federal purposes. >>> Michael: Jay, so what, what, what happened over the last couple of years? Has been legislation in different -- that the IRS has made some legislation in the different states. Talk to me about the new legislation, this and this workaround. What do we mean by workaround? >>> James: Sure. Sure, Michael. So, what happened was in 2018, the state of Connecticut, which New York is, is a higher tax state up here in the Northeast United States. They came up with
what we call SALT Workaround or SALT Limitation Workaround, for what we call workaround or pass-through businesses, this is partnerships and S corporations. And in the state of Connecticut, they, they passed a law that said, if you are a pass-through business entity, you now have to pay an entity level income tax, whereas prior to 2018, generally one of these didn't pay state income tax in the state of Connecticut. Some states do that, but Connecticut did not. So what Connecticut is doing is they're now imposing a tax liability at the business level, not the individual level, and therefore, because the tax is paid by the business itself, it is deductible, but what we call above the line on your federal tax return. It's, it's not an itemized deduction, nor is it subject to that $10,000 limitation that individuals have to limit their, their state local income and property taxes. So, it's, you're, you're sort of unfree that the deduction now from the federal tax limitation. So, Connecticut passed this tax
in 2018. And just last year, the IRS came out with, with the notice, which essentially looked at Connecticut's workaround and, and they blessed it. They said, yeah, this, this is not something that we think is abusive and we are -- it, this is not something that, when you get to the individual investor level, they would have to add that tax back to the federal tax avoidant, coming in and limited to the 10,000, $10,000 limitation. So once the IRS put that notice out, several other states started to look at what Connecticut did and said, well, that looks good for us too. So, we saw -- New Jersey do it. There's one into effect in 2019 -- I'm sorry, in 2020. Rhode Island -- there's, you know, several other states have now come up with these, these SALT workarounds. Now, unlike
Connecticut's, over in New Jersey, it's elective. So, the business doesn't have to subject itself to the tax, unless it wants to. And the IRS even blessed those situations too, where it's now even more obvious that this is a workaround, the federal limitation, IRS says that's okay. It's still a
business deduction, because it's being paid by the business entity itself, not the individual and therefore there is no limit at the federal level. >>> Michael: I think what I really need both of you to do is to explain on an individual basis -- let's take an example of an individual who may be operating as an LLP, because it says it's partnership. Correct? So, it has to be a partnership? >>> James: Yes.
>>> Christian: And generally pass away -- at any in general. So, it could be a partnership and LP, LLP, an LLC treated as a partnership or a, or an S corporation, where you have that flow, where you have that flow through of the income. >>> Michael: So why don't we, why don't we try to take this as an independent contractor? So, I can explain this to the lay people, including yours truly. Okay? Of, of what the, the, the item is. Okay? Somebody -- let's take a physician. A physician who's working in a practice, who's working in a, it may be a LLC or a subchapter S. Explain to me what this means. Okay? The business had a quarter of a million dollars of business.
Okay? The tax -- what is the tax rate and how do they deduct it? >>> James: So, for the New York tax, this physician would usually have to be practicing inside of New York State. He would be a New York State resident presumably as well. So his S-corporation, if it elects that the tax will pay it income tax through the state of New York now, whereas in the past, it, it would just pay what we call a minimum tax just based on its growth revenue. Usually a pretty small amount. --
>>> Michael: So, this is an additional tax is what you're saying? >>> James: This is an additional tax to the, to the minimum tax or, or in the gross receipts tax imposed on S-corporations. -- So, the tax rates on the first, I believe $2 million of income is, is 6.85%. So, if his business, you know, earned, say $100,000 net, he'll pay a tax of $2,650. That tax becomes a
deduction on the company's federal tax return and it passes through to him -- the individual shareholder, as an ordinary deduction. So, he will only pay federal income tax on the net difference, you know, roughly what, $97,000 -- around there. That, that entity level tax of $2,650 is not subject to the $10,000 SALT limitation. So, he gets that, you know, that there's a full deduction for that tax. So that's where the advantage comes to him. Otherwise, without that entity paying the tax, he would be paying the tax to New York personally, where it will be subject to that $10,000 cap and presumably the physician paying a lot more than $10,000 and other state income taxes and property taxes in the state.
>>> Michael: Now -- how do they learn about this, this additional, this workaround? Okay? The standard subject is everybody's upset about SALT. Okay? That that's, that's a standard situation. From what I hear, it sounds like this is an additional tax that the person is paying. And even though it's deductible, it's still an additional tax! >>> Christian: It's an additional tax at the entity level, but it's really an alternative tax, that you're getting the benefit of the deduction at the actual business level, where the SALT limitation does not apply. As an owner of the pass-through entity, say in the partnership, if I owned 50% of a partnership, my half of that, of that business's income will already come to me net of that state and local tax deduction. And when I filed my personal income tax returns to
the state of New York, for example, having made that election -- I will be entitled to a dollar for dollar credit for all of the taxes that were paid on that distributive share of that income that I'm now reporting on my personal income taxes. And -- since these rules are, are relatively new, I mean, it's really incumbent on all of the all individual taxpayers to reach out to their CPAs or whoever's going to be their ta -- their advisors, their tax attorneys, to find out about these different programs. Because the, the rules in New York are relatively new. Similarly, with New Jersey. I last year, when the BAIT tax was, recently was enacted the -- there's still a lot of issues and we're working through in this compliance year where the states are -- I mean, the states came up with this grandiose plan to, to work around that state and local tax limitation, but I mean, we're still working out those -- and making sure that the, how we calculate the income at the entry level is going to correspond with how we're going to report that income individually, and making sure that we're equalizing the amount of tax that we're paying both at the entity level, as well as at the individual owner level, so that way that the, when we get that credit, it's going to offset dollar for -- it's going to offset completely the income that we receive from that business interest.
>>> Michael: What if they don't want to take advantage of this program? Are they required? Jay? >>> James: You're, you're not required to under the laws in New York and New Jersey, and most other states have enacted these past new taxes. The only one off the top of my head where you, you have to do it is Connecticut. So -- but again, most businesses, if it's a profitable enterprise, it's generally probably going to be worthwhile to at least consider doing it. There may be situations where it may not be such a good deal, depending on your investors. If they are residents of a state that maybe won't give a credit against its tax for the taxpayer to New York or New Jersey. Like, I'm here in Pennsylvania, Pennsylvania's
saying we're not giving any credits for taxes paid by entities, where the resident individuals such as myself as a Pennsylvania resident. So, I would lose. Really should be a problem because it makes no sense to it likely to be if it's a business showing losses. Also, if the business is a pass-through entity, which, which doesn't have any individual owners, it may not make sense, especially if it's all corporate owners that it's re you know, there is no SALT limitation at the corporate level. So there probably doesn't get you anything by doing it. But, again, if it's a profitable business in with most of its resident or most of its owners in living in New York, New Jersey, Connecticut, I think for those businesses, this, this may be a real home run for them for the owners here.
>>> Michael: I mean, when you say there's a real home run, I really want to try to identify an example. I mean, we utilized the physician before. Okay? Let's, let's take a sole proprietor, who's doing some type of business. Okay? And
right now, they've been operating as a limited liability corporation or, or an LLP. Okay? What, what, what should they do? What should their advisor, okay? This is not easy to understand in a, in initial approach. How do you educate the consumer that this is a program over there? Because what they hear about SALT is this a possibility that it might be repealed. So, let's try to figure those points out. >>> James: So, Michael, you
mentioned a sole proprietor. Let's first stop right there. Sole proprietors can't elect into this tax, in New York and New Jersey and Connecticut. So, you'd need to perhaps revise the way that your entity is structured. You could still be an LLC, but maybe you have a 1% owner, maybe it's your spouse. Maybe you form a corporation this as a special purpose entity to get your company your LLC into the realm of partnership taxation. So, once you're a partnership, then you can elect
into the tax and pay it. And now the partnership, which used to be your proprietorship, will be subject to the tax, you'll pay the tax and you'll get deductions for it. Those deductions will reduce your federal taxable income. It will also reduce your federal self-employment taxes. So, you're getting the benefits twice there. You would see both ordinary federal taxable income and self-employment taxable income. So, you get a little bit more bang for your buck there,
if you're operating as a sole proprietorship, and you convert that to a partnership. You can also convert someone as a corporation and, and do it there as well, especially if all your business is inside of New York State, that may also make sense. So that way, you don't have to bring all the second partner or second owner, you can just elect an LLC, you can make an election to be taxed as an S-corporation. >>> Michael: Are there specific states, Christian, then it's better to do this with? Okay? Is it California? I hear Connecticut. I hear New Jersey.
I hear New York. Okay? >>> Christian: Yeah, there, there are a lot of states that are actually jumping on that bandwagon to enact legislation to establish these pass-through entity tax regimes as a workaround for the state level tax limitation. California's legislation is still pending. The states that we are currently focusing on our New York, New Jersey, Connecticut, Rhode Island. These are states that have already enacted over the last couple of years, these new, these new tax schemes, to circumvent that, to circumvent that, that tax cap on the state and local tax deduction. If we look at it in the context of an example, as you were mentioning, you know, it let's assume that you have, well, Michael and Jay LLP. You, you, you have Michael
and Jay that are equal partners in this limited partnership. And the limited partnership generates say 2 million of ordinary business income. Now, typically you wouldn't -- as partners, you would get that -- you would get that income as a K-1. You report, each of you would report a million dollars in, in ordinary business income from your interest in that partnership on your 1040. Well, let's just assume that your tax
rate at a million dollars is the 30%. So, so just assume that for state purposes, you're paying tax at 10%. So, your state tax, your state tax expense on that million dollars of your ordinary business income from your partnership interest is $100,000. Obviously, under the new federal rules, that $100,000
is capped at 10,000. So, you're not getting the benefit for federal purposes of a $90,000 deduction that would have existed pre-tax reform. Now with the new state -- with a new pass-through entity taxes in New York and Jersey, and some of the other states, if you make the election at the entity level, your limited partnership can now pay the taxes on the $2 million. And let's say the same tax rate applies at the 10%. So, the
entity is going to be paying $200,000 to, say the state of New York, on the -- the 2 million of ordinary business income. When it comes time to distribute that income, or to treat that income for you individually, when you receive your K-1, you're now getting instead of the million dollars, let's say your distributor, your gain is the 50%. You're getting a K-1 for $900,000, which is net of that state tax deduction, because it's already baked into the ordinary business income. So, your K-1 already has that tax deduction already taken into consideration. So, when you report your state tax -- your
income, say to the state of New York, you're not reporting a million you're reporting 900,000. And to the extent that you're paying taxes on that income, you're now getting a dollar for dollar credit theoretically, on the taxes that were already paid under that pass-through entity tax -- >>> Michael: Many people that we know get involved with real estate partnerships. They are -- they want to buy an asset. They're interested in buying an investment right now. How would you recommend they set it up? Okay? Because what you're talking about in the past is existing businesses. I'm talking about future businesses. What's the best way to set up a new
business, if you're in New York, New Jersey or Connecticut? -- Or Pennsylvania. Okay. -- >>> James: Well typically, generally you don't want to use a corporation, whether it's C-Corp or an S-corporation or real estate, or -- you know, it used to be the 11th commandment thou shall not put real estate in a corporation. So, usually you want to purchase it and hold it in a limited partnership or an LLC, something that's, that's taxed as, as a partnership. Because it's easier to transfer interest back and forth and take property out to the property without incurring tax liability. Just, just partnerships are, are usually the better vehicle for holding real estate. And then maybe you
purchase some, some real estate in New York City or in New York or in New Jersey, if it's going to be, you know, throwing all taxable profits and that that's an important distinction to make -- Because you get the appreciation and all this other good stuff, you know, that, that real estate pros law, where maybe it's cashflow positive, but on the tax return showing loss, if it's going to be showing, shrowing all taxable profits, at that point, you'd definitely want to consider like digging into a state -- entity level or PTE tax, to get that tax deduction now paid by the entity itself, that tax paid by the entity essentially flows through down to the individual investors where they can use it as a credit against their New York State or New Jersey income tax. So that's, you know, in my mind, I think just to answer your question, I think, I think a partnership in is usually the best way to go, with acquiring real estate. >>> Michael: What about an estate? You know, a trust during the estate, being a partnership, being a partner in a, in a transaction? >>> James: Yeah, certainly, the estates and trusts can be partners in partnerships and can be a little more difficult to make them owners of S-corporations, but it can be done. But in most states, they tax estates and trusts for
income tax purposes, as if they are individuals. There's really no distinction between the two. Same at the federal tax level. So, in New York, if you have a New York trust, it could be a partner in a partnership doing business in New York and, and that same pass-through entity level tax and then the resulting credit will flow down into that New York State resident trust and being used as, as a credit against its New York State income tax. >>> Michael: Here's a question. Can I amend my tax return from
prior years? >>> Christian: No, unfortunately not. Once -- you have a certain timeframe to make the elections. In New York, once you make the election, it's irrevocable. For the 2021 tax year, we have until
October 15th of this year to actually make that election. In other states, like New Jersey for example, the election may be revokable up until the actual due date of the return. So, the rules will vary by state. As was mentioned earlier, you have other states like Connecticut, which are mandatory. So, you don't have, you don't have a choice. But keep in mind that
once you're, once you make the election and you file your return, you're stuck, whether you made it or not. >>> Michael: Quick question and getting slightly off the topic, what happens if they appeal the, the 1031 rule for exchanges? >>> James: If that gets revealed? >>> Michael: Yes. >>> James: Well, [laughs] that will certainly upset a lot of people that get engage in real estate transactions all the time. So here we're talking about the federal policy, which has been on the books for -- >>> Michael: Close to a hundred years. >>> James: -- I'm guessing since the fifties, at least, going back to the Starker case, and we're going back the ways we're 1031 exchange has been around for a long time that I know that, that they have the gumption to get rid of that, but perhaps they do, they already did it with, with anything other than real estate a couple of years ago. So maybe, yeah, that
could be problematic for a lot of people that are sitting on real estate with substantial gains built into those properties. >>> Christian: Repercussions from a state tax perspective, we're going to be disastrous, depending on how the states treat that any changes to the federal laws will depend on how the state will either conform or continue to follow the old rules. And most states given that this is more going to be more of a revenue generating provision, I would suspect that most states would actually conform to that, to any repeal of our federal level. >>> James: Yeah. And if they did, that would be perhaps a reason to like to move into this tax. If you're going to be
selling -- now you have to sell the property and then recognize the gain. And whether you do flip it or exchange it for another or not. So, if you're going to be forced into that thorn bush, well, you might as well just make, make the PTE tax election and get some state -- >>> Michael: So, here's the last question which is, you know, relating to both of you as professionals. How does the consumer or the individual learn about this workaround? I mean, I've done research and I've gone on the web and all the other information. How are you educating your customers and, and, you know, people in the general public about the product, you know, what they should be doing? >>> James: Personally, my firm has put information out on this. You go to our website. You can read all about it. I, I, I spent
a couple of days last week, putting together with one list of frequently asked students. I think I have I'm up to 30 or 40 questions in there that we, we anticipated people would be having. So, you can look at that. I'm sure Christian you, your firm has other information on your website as well. >>> Christian: Yeah, we we've issued a lot of the tax alerts and other thought leadership pieces to inform our clients and the general public. We actively reach out to our clients that we identify that are going to benefit from these tax elections as they arise as -- I mean, most of our clients and most businesses nowadays operate in a multi-state environment. So as
more states start adopting these new pass-through entity workarounds, I mean, we're informing everybody to identify those opportunities where they can actually save tax. >>> Michael: So, I think you guys have been very informative than helpful. I still need a refresher course after this class on the following. But I'd like to thank Christian, I hope
you have a nice day in Southern California. Jay, enjoy the city of brotherly love. And I'll see you next week. >>> James: Okay. Thank you, Mike.
>>> Christian: Thank you, Mike. ♪ [Theme Music] ♪