On November 9, 2020, the IRS released Notice 2020-75, announcing the Service’s intention to propose regulations clarifying the treatment of state and local taxes paid by a partnership or S corporation for purposes of federal deductibility. These state and local tax payments will be exempted from the federal limitation on any individual who is a partner in the partnership or a shareholder of the S corporation.
For years ending after 2017 and before December 31, 2026, individual taxpayers are limited to a $10,000 ceiling on the federal deduction for state and local taxes ($5,000 for married individuals filing separately). However, proposed regulations clarify that specified income tax payments are deductible by partnerships and S corporations in computing non-separately stated income or loss.
A specified income tax payment is defined as any amount paid by a partnership or an S corporation to a state, a political subdivision of a state, or the District of Columbia, to satisfy its liability for income taxes imposed by a jurisdiction on the partnership or the S corporation. Some jurisdictions may impose an entity-level tax for partnerships or S corporations that do business within the state. It is uncertain if these entity-level payments must be taken into account in applying the state and local tax deduction limitation at the partner or shareholder level. The IRS and Treasury Department are aware of this uncertainty.
The proposed regulations should clarify that any specified income tax payments made by a partnership or S corporation will be reflected in the distributive or pro-rata share of income or loss passing through to the partner or S corporation shareholder. With the income tax payments reflected in the income or loss passed through to the partner or shareholder, the individual will have already received the benefit of taking the deduction for the specified tax payments at the partnership or S corporation level. If the state and local tax payment had to be reported at the individual level and could not be deducted at the partnership or S corporation level, the individual could potentially be limited by the $10,000 federal limitation, thereby increasing the individual’s taxable income and, ultimately, the tax liability due on the individual’s return.
Your CBIZ tax professionals will continue to update you on the status of these proposed regulations.
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