SALT Cap Compromise On The Table In Next Congress

SALT Cap Compromise On The Table In Next Congress

While a full repeal of the 2017 tax overhaul's cap on the deduction for state and local taxes remains uncertain under the coming Joe Biden administration, pressure from congressional Democrats is likely to result in compromise.

Congress could change the $10,000 limit on state and local tax deductions in legislation providing relief during the coronavirus pandemic, or authorizing highway funding.

President-elect Biden has not indicated that repealing the cap is a priority for him, and the opinion of Janet Yellen, who is expected to be his treasury secretary, is not clear on the matter. But it is clear that the Biden administration will face competing pressures, especially from Senate Minority Leader Chuck Schumer of New York, a fierce foe of the cap, and from Republicans who want to preserve as much as possible of the Tax Cuts and Jobs Act, the 2017 law that included the cap. While a full repeal appears unlikely, that could leave some sort of compromise as a possible solution.

Compromise could take various forms. One could be a legislative elimination of the so-called marriage penalty, which currently limits all households to $10,000 in state and local tax deductions, whether the household is composed of a single individual or two married taxpayers filing jointly. An elimination would let married couples filing jointly deduct $20,000 and married couples filing separately to deduct $10,000 each. Or the entire cap could be raised, with lawmakers who want to raise the cap agreeing to give ground on some of the tax extenders — temporary tax policies — favored by Republicans.

"I don't want to rule out the possibility of repeal, but overall I don't think there's going to be the support," said Marc Goldwein, vice president of the Committee for a Responsible Federal Budget, who like most policy observers strongly opposes repealing the cap. "But there are changes that could be made on a smaller margin."

The Biden transition team did not immediately respond to requests for comment.

One hint for a way to mitigate the cap has been suggested by the current administration. On Nov. 9, the U.S. Treasury Department and the Internal Revenue Service released a notice stating that the agencies intended to promulgate guidance that would bless the recent trend of states taxing pass-through businesses at the entity level.

The notice indicated the agencies would consider such taxes eligible for a federal deduction, and for states that wish to grant it, a state tax credit, too. The agencies made clear in the notice that they were making that interpretation with full knowledge that such taxes can be a way for pass-through members to work around the SALT cap.

Allowing state taxation of pass-throughs as a SALT cap workaround benefits only one segment of taxpayers, but now that the agencies seem to have given it the OK, it is something that every state could implement if legislators want to. In Connecticut, one of the first states to tax pass-throughs at the entity level, the program appears to be working well. The state tax agency is collecting revenue faster than it did when pass-throughs were only taxed at the partner level, after income had flowed down to them, Edward Renn of Withers told Law360.

"I don't know why all 50 states shouldn't [do this]. It's not the whole problem, but at least for S corps and LLCs and partnerships, it provides some relief for those taxpayers," Renn said. "And I think it really does improve [tax] collections, the rapidity of collections and the efficiency."

Goldwein suggested that federal tax agencies under a Biden administration might look at other SALT workarounds with a new eye as well. As of now, the agencies have disallowed states' attempts to institute workarounds by granting individuals federal deductions and state tax credits for making charitable contributions, saying such arrangements amount to a quid pro quo.

"It's not the easiest thing to do. But they could say: 'We think it was interpreted wrong before. And we're reinterpreting it,'" Goldwein said. "Or maybe there's a new thing — a new workaround will be discovered, and they'll look the other way on that. So I think it could happen in different kinds of ways."

The broader range of options for changing the SALT cap, however, still appears to exist via legislative means. Congress will be considering several key pieces of legislation that have tax components, and within each, or a combination of them, is the possibility of horse trading to mitigate or even repeal the cap. One of the bills would likely be whatever Congress does next to address COVID-19 relief. Another opportunity could be with the authorization of highway funding, as the Highway Trust Fund could begin to run out in 2022 and Congress is expected to wrestle with a funding package next year. And the SALT cap could be addressed in legislation on suspension of the debt ceiling, which is set to expire next August.

Zach Rudisill, a partner at Akin Gump Strauss Hauer & Feld LLP specializing in various policies, including tax policy, told Law360 that he thought there would be ample opportunity for the two sides to debate the SALT cap within legislation over the next year.

"I think there will be several tax bills that end up passing Congress in 2021. This will all be in the mix" in determining the fate of the SALT cap, said Rudisill, who was tax counsel for Sen. Rob Portman, R-Ohio, when the TCJA was enacted.

And then, he noted, there is reexamination of the TCJA itself. The law is full of provisions with various expiration dates. The SALT cap does not expire until 2025, but some provisions that Republicans favor begin to sunset well before then.

For example, after 2021, businesses would have to deduct research costs over a period of years, rather than being able to deduct them right away. At the same time, the deduction for business interest expenses would tighten up, with the deduction going from 30% of earnings before interest, taxes, depreciation and amortization, or EBITDA, to 30% of earnings before interest and taxes, or EBIT. Republicans will likely want to extend business-friendly provisions, and in exchange for keeping them may be willing to negotiate changes to the SALT cap.

"As we get into this next year, expirations of some of the business provisions start to come on the horizon," Rudisill said. "I think there's likely to be a conversation around a number of these."

Biden may also want to push some of his own ideas to go along with eliminating or mitigating the SALT cap. The SALT cap, which paid for many of the TCJA tax cuts, disproportionately affects taxpayers who live in high-tax states such as New York, New Jersey and California. As a result, the pay-for comes disproportionately from those states.

One of Biden's proposals is to restore the Pease limitation, which would limit itemized deductions for those with taxable income of more than $400,000. Another is to raise the top marginal rate to 39.6%, from the current 37%, and to cap the tax benefit of itemized deductions for wealthier taxpayers at 28% of value.

SALT Cap Compromise On The Table In Next Congresshttps://www.cbiz.com/Portals/0/Images/SALT-Cap-CBIZ.jpg?ver=2020-12-01-130514-707https://www.cbiz.com/Portals/0/Images/SALT-Cap-thumb.jpg?ver=2020-12-01-130510-513Further changes to the limitation on state and local tax deductions may be on the docket for the new Congress.2020-12-01T18:00:00-05:00Further changes to the limitation on state and local taxdeductions may be on the docket for the new Congress.Regulatory, Compliance, & LegislativeFederal TaxTax ReformNo