The Internal Revenue Service released IRS Notice 2020-75 on November 9, 2020, clarifying its position on State and Local Tax (SALT) workaround laws passed by several states. In Notice 2020-75, the IRS outlined in which circumstances pass-through entities (PTEs) can pay State income taxes at the entity level and take a Federal deduction for the State income taxes paid.
Maryland was among one of several states to pass a SALT workaround, the goal of which was to negate or mitigate the $10,000 SALT cap imposed by the Tax Cuts and Jobs Act on individual taxpayers. Maryland’s SALT workaround imposes a new entity-level tax on PTEs while providing Maryland resident PTE members with a state income tax credit for the same amount. Until it issued Notice 2020-75, the IRS had not issued any positive guidance regarding State SALT workarounds, leaving businesses and their tax advisors in limbo as to whether they could pursue a State tax deduction at the entity level.
For Maryland taxpayers who own a pass-through entity, such as s-corporations and partnerships, the tax is calculated based on distributable income. To be eligible for the credit, which is only available in tax years starting January 1, 2020, PTEs operating on either an accrual or cash basis must pay the tax by December 31, 2020. Taxpayers who have made Q1, Q2, and Q3 estimated payments at the individual level will not be able to move them over to the PTE level.
Issues Needing Clarification
One of the more significant issues needing clarification is how the State is going to treat Maryland PTEs with both resident and non-resident members. As it stands now, we believe non-resident members will not be able to participate in the entity level tax and thus it may be difficult to match the economics of the tax deduction with the benefiting owner. There are also unresolved issues as to whether a resident member of a PTE needs to pay taxes on all income in Maryland along with payments to other states if the PTE files a return in multiple states.
Issues for PTE Consideration
Making the election and paying the entire year’s tax at the entity level may put a strain on cash flow in a year that businesses are already facing cash flow issues.
Whoever is making the election, whether it is the tax matters partner, an officer, or the owners themselves, will need to ensure that other members or shareholders are informed, and perhaps even coordinate with legal counsel to amend the entity’s operating documents accordingly.
As Maryland’s law is unique, and IRS Notice 2020-75 does not address any State’s law specifically, we are watching daily for more guidance from both Maryland and the IRS. Taxpayers should work closely with their tax advisors to evaluate making the Maryland election and depositing the tax before December 31, 2020, as it is unlikely we will receive more guidance before year end.
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Thank you for your article on MD PTE to pay state taxes at the entity level . My question is. What form does one use to pay the taxes at the entity level and how do we make the election before 12/31/2020 as there seem not to be any additional guidelines from State of MD. If I understand ,on the Federal level, the tax will be deducted on K1 as part of regular deduction not a separate line on K-1. Thanks for you brief answer
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Rena, thanks for your comment. You would use MD Form 510D to make the payment, which you can find on the Maryland Comptroller’s website, at: https://www.marylandtaxes.gov/forms/20_forms/510D.pdf.
We believe the deduction will be connected with the individual Maryland resident, and they will receive a credit for the tax paid on their behalf, which we believe will be reflected on their K-1. Presently we do not have drafts of other 2020 tax forms, so the presentation, whether it be Federal or State is a bit of a guess.