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States Have Already Picked the Treasury's Pocket with SALT Workarounds

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AP Photo/Steven Senne

Before Congress completes consideration regarding either or both mega-infrastructure bills, it needs to determine how it will offset the reduction in federal tax revenues that will occur resulting from the many states’ legislation passed in 2021 to “work around” the state and local tax (SALT) deduction cap of $10,000.


It matters not whether each or any member of Congress believes the $10,000 SALT cap is justified and/or unjustified or whether the members of Congress believe the “workarounds” are appropriate. The loss to Treasury could be in the hundreds of billions of dollars. The loss of revenues either needs an offsetting tax increase or clarity that it has been considered in the calculation of expected future deficits. Either decision should impact the ultimate size of the mega-infrastructure bills.

The Tax Cuts and Jobs Act of 2017 placed a cap on state and local tax deductions (SALT) of $10,000. Simultaneously, the Act increased the standard deduction from $6,500 to $12,000 for single individuals and $13,000 to $24,000 for married couples. The increase in the standard deduction was in great part made to offset the loss of the SALT deduction. Congress also decreased the top federal tax rate from 39.6% to 37% and enacted a qualified business income deduction.

High tax states believed that the $10,000 cap on SALT deductions was unfair as there was no previous cap on SALT deductions (save for the possibility of alternative minimum tax issues). Immediately after the passage of The Tax Cuts and Jobs Act of 2017, these states immediately began considering various legislative alternatives to allow their residents to avoid the $10,000 cap.

In November 2020, the Internal Revenue Service released Revenue Notice 2020-75 announcing that partnerships and Subchapter S Corporations could deduct SALT directly against the income produced by these entities thus avoiding the SALT cap limitation for income earned by these entities. (It is assumed that LLCs are considered partnerships under Revenue Notice 2020-75.)


Following the release of Revenue Notice 2020-75, most of the high tax states began to consider and have now passed “workaround” legislation. More than a dozen states including New York and California have passed such legislation effective for 2021. Each state has its own specific legislative spin on their “work around.”

The state “workarounds” are a tax shelter salesperson’s dream. There is no risk to the taxpayer and no cost to the state passing the legislation. State tax revenues will remain the same; federal tax revenues paid by the state residents will decline dramatically. The only step necessary for the taxpayer to be able to deduct SALT which are the result of a partnership, LLC or Subchapter S corporation’s activities is to have the entity pay the tax directly to the state rather than have the individual pay the tax with their individual tax return. Perhaps it also requires the payment to be made to a different address. 

It does not appear that anyone has modeled the impact to Treasury of the result of Revenue Notice 2020-75 and these state legislative activities. 

The only discussion that has emerged has been with respect to the cost to the Treasury if the entire SALT cap is removed. CBO projected in 2019 that the elimination of the SALT cap for the calendar year 2021 would be $88.7 billion. This commonly referred to estimate was made before “workaround” legislation was passed by various state legislatures. 

The Tax Policy Center made its projection in 2016 predicting a cost of $738.2 billion in lost revenues to Treasury if Salt was eliminated for the five years beginning in 2021. This projection was made before both the the Tax Cuts and Jobs Act of 2017 and the state “workaround” legislation.


The “workaround” legislation, the federal law changes in The Tax Cuts and Jobs Act of 2017, and the combination of these has made previous studies nothing more than historical footnotes. This cat is long since out of the bag. A large percentage of the revenue losses to Treasury are already lost due to state legislation.

The reduction in federal revenues from the “workarounds” will result from a plethora of existing activities and planning: (a) taxpayers owning the described entities will now pay their taxes to the state using entity checking accounts, (b) taxpayers will convert single member LLCs and sole proprietorships into the described entities, and (c) taxpayers will find ways to convert all kinds of income into income which their state will consider business income. Revenue Notice 2020-75 will further result in the lowering of adjusted gross income and remove business related SALT from the AMT. 

Many small business owners who are currently taking the new higher standard deduction will continue to take the new higher standard deduction along with paying their business-related SALT through their described entity tax returns providing a windfall for many small businesses. Every taxpayer making their state tax payments through their qualifying entities will see their adjusted gross income decline and therefore will see other available deductions and credits be more available to them. Employees will not receive a penny of benefit from the state "workarounds."

Over the next five years, the impact of the state "workarounds" to Treasury revenues could easily be in the hundreds of billions of dollars. CBO needs to estimate this amount. (While all the current Congressional discussion has turned to trillions because of the infrastructure bills, note that the total federal cost of Hurricane Katrina was $120 billion.)


“According to reports, Republicans are still furiously debating changes to their bill. And one knows when they will put the bill on the floor. A bill like this deserves weeks of debate on the floor," said Charles Schumer on November 29, 2017. This should be what is happening in 2021.

Ways & Means along with CBO should be studying the impact to Treasury revenues from the SALT "workarounds." All we know at this point is that already passed state legislation while costless to the states is going to cost the Treasury billions and billions. No one seems to have noticed.

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