The Internal Revenue Service (IRS) has published a Notice of Proposed Regulations clarifying that state and local income taxes attributed to and paid by a pass-through entity are permissible tax deductions for that pass-through entity.
What this means for you:
The proposed regulations will permit partnerships and S corporations to deduct the full amount of state and local income taxes attributable to their taxable income.
Explanation:
Previously, state and local income tax deductions took place at the individual level—not at the pass-through entity level. The Tax Cuts and Jobs Act mandated a $10,000 annual limit on state and local tax deductions for individuals. The notice validates a "workaround" that has already been adopted by some states, including New Jersey and Connecticut. The workaround either mandates or enables pass-through entities to pay and deduct that state and local taxes directly (rather than business owners, who are capped at $10,000).
In the announcement, the IRS stated that these forms of state and local tax payments would be regarded as deductible business taxes, reducing the federal income passed on to the business owner. The IRS stated it would respect the deduction whether paying the taxes at the company level is a requirement or an election.