A changing tax landscape is on the horizon for the new year. Many of the provisions of the 2017 Tax Cuts and Jobs Act (“TCJA”) are scheduled to expire at the end of the year. President-elect Trump has also proposed a variety of new tax law changes that are intended to benefit various categories of taxpayers. Of course, any tax cuts will need to be offset by revenue raisers, which President-elect Trump asserts tariffs can do. Whether or not these particular tax policies are enacted, we know the U.S. federal income tax landscape will change in 2025. This Memorandum discusses the current limitation on deductibility of state and local taxes, how states have responded and what taxpayers should expect going forward.
Note: This Memorandum should be read in conjunction with our other Memorandum on the application of the self-employment tax to limited partners of investment managers.
Background
The TCJA imposed a $10,000 limitation on the deductibility of state and local taxes for federal income tax purposes (the “SALT Cap”). This SALT Cap is particularly impactful for taxpayers in high tax states, such as New York and New Jersey, which have high income and property taxes.
Various states responded to the SALT Cap by enacting elective pass-through entity taxes (“PTETs”). PTETs generally allow entities that are taxed as partnerships or S corporations to pay state and local taxes at the entity level, rather than partners and shareholders paying taxes on their respective distributive shares of income from the entities. The pass-though entity can claim the amount of PTET paid at the entity level as an ordinary business deduction and thereby avoid the SALT Cap.
As of 2024, thirty-six states have an elective PTET (including New York, New Jersey and Connecticut) and two other states impose a mandatory entity level tax. Of the remaining twelve states, seven do not impose a state level income tax and five do not offer a PTET. New York City has both an elective PTET available to pass-through entities that have made the New York State PTET election and a mandatory unincorporated business tax, which applies to partnerships, LLCs and sole-proprietorships.1
While many states’ PTETs are effective indefinitely, some expire when the federal SALT Cap expires or on December 31, 2025. Colorado, Iowa, Massachusetts, Michigan, Minnesota and Oregon have each tied their respective PTET legislation to the federal SALT Cap. Consequently, if the SALT Cap expires after 2025, those PTETs would no longer be available to pass-through businesses in those states. The PTET laws in California, Illinois, Utah and Virginia will expire at the end of 2025 and would require additional state legislation to be extended.
What to Expect in 2025
It is still uncertain what the incoming Congress and the President-elect will do about the SALT Cap. For example, the SALT Cap may be doubled to $20,000, benefiting taxpayers who utilize PTETs and have high property taxes. It is also uncertain whether changes will be made to state PTET laws as a result of changes to the SALT Cap. For example, taxpayers in California, Illinois, Utah and Virginia will need to assess whether their PTET laws will be extended.
If the SALT Cap expires, taxpayers who elect to pay a PTET should discuss with their tax advisers whether this election continues to make sense for their businesses. Given that many PTETs require payment of estimated taxes earlier and in greater amounts than the corresponding personal income tax, taxpayers may terminate their PTET election for cashflow reasons. However, state and local taxes are not deductible for alternative minimum tax (“AMT”) purposes. Therefore, if the SALT Cap expires or substantially increases, taxpayers may want to continue their PTET elections if it results in overall tax saving, after the AMT is taken into account on their personal income tax returns. Many PTETs (including New York and New Jersey) require an annual election into the PTET, so the decision would be whether to make this election for 2026.
Final Remarks
Seward & Kissel LLP actively monitors tax changes and their impact on the investment management industry. For additional information on this Memorandum, please contact a member of Seward & Kissel’s Tax Group.
