Maryland Pass-through Entity Election Can Create Additional Federal Income Tax Deduction

Maryland residents that own a pass-through entity (i.e., partnership or S corporation) can create an additional federal income deduction by making the new Maryland pass-through entity tax election. In response to the $10,000 state and local tax (SALT) deduction limitation enacted as part of the federal Tax Cuts and Jobs Act (TCJA) of 2017, Maryland, as well as a number of other states, has created an election that allows a pass-through entity to be subject to an entity-level Maryland income tax on the portion of the business’ income attributable to its resident owners. The tax paid by the entity will create a business deduction that is not subject to the $10,000 SALT deduction limitation, as the limitation only applies to individuals. The entity-level deduction created by the election will flow-through to a Maryland resident as a decrease in the resident’s distributive share of pass-through entity income reported on their personal income tax return.

Further, any uncertainly with respect to the IRS permitting the additional deduction at the entity-level was addressed in the recently-issue IRS Notice 2020-75. The Notice indicates that the IRS will be issuing regulations reflecting that pass-through entities (PTE) will be able to deduct net income taxes imposed directly on a PTE. Notably, the Notice provides that the entity-level deduction will be permitted when an entity-level tax is imposed on a pass-through entity without regard to whether the entity-level tax is the result of an election or whether the partners or shareholders of the entity receive a partial or full deduction, exclusion, credit, or other tax benefit based on their share of the tax paid by the pass-through entity to satisfy their income tax liability. Finally, the Notice also clarifies that the payment of an entity-level income tax by a pass-through entity is not taken into account in applying the SALT deduction limitation to any individual who is an owner of a pass-through entity.

Depending on the particular business, there may be some additional considerations to think about in making the pass-through entity tax election. These include any adjustments that need to be made to previously calculated fourth quarter payments for a Maryland resident as well as the treatment of Maryland nonresidents that own an interest in a pass-through entity making the pass-through entity tax election. Still, if you are a Maryland resident that owns an interest in a pass-through entity that does business in Maryland, this new election will almost certainly be beneficial to you.

The Maryland Comptroller has recently issued a payment voucher that can be used by a pass-through entity seeking to make the election. Taxpayers wishing to create a 2020 tax year deduction will need to make the payment before the end of the year.

Please contact your Aprio tax advisor to discuss taking advantage of the new Maryland pass-through entity tax election.

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