State and Local Tax (SALT) Limitations and Workarounds

Issue July/August 2022 July 2022 By Wilton B. Hyman
Taxation Law Section Review
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Wilton B. Hyman

I. Introduction

One of the more controversial and disruptive tax changes in the Tax Cuts and Jobs Act of 2017 (Pub. L. No. 115-97) was the limitation imposed on state and local tax deductions for individual taxpayers.1 This change was controversial because it disproportionately harmed states and localities with high-income residents, particularly those states and localities that imposed higher income and property taxes, which fund government services, and are typically led by Democrats.2 The change was disruptive because of the efforts made by states to provide workarounds so that their residents could avoid, or minimize, the impact of the limit on their previously unlimited state and local tax deduction. 

This article will discuss § 164(a), and the changes made to it under the Tax Cuts and Jobs Act. It will then discuss the ways in which states have attempted to provide workarounds for their residents, to avoid the state and local tax limit. Finally, this article will discuss Massachusetts’ recently enacted legislation, providing a tax workaround for owners of interests in pass-through entities. 

II. State and Local Taxes

IRC § 164(a) allows taxpayers to deduct: (1) state, local and foreign real property taxes; (2) state and local personal property taxes;3 and (3) state, local and foreign income, war profits, and excess profits taxes, for the taxable year in which they are paid or accrued, whether or not connected to a trade or business.4 State and local taxes are taxes “imposed by a State, a possession of the United States, or a political subdivision of any of the foregoing, or by the District of Columbia.”5

§ 164(b)(5) allows taxpayers to elect to deduct general sales taxes, in lieu of state and local income taxes.6 State, local and foreign taxes not listed in those previous categories are also deductible, if paid or accrued in carrying on a trade or business or a profit-seeking activity under § 212.7 

With the exception of state, local and foreign property taxes, paid in connection with a trade or business or profit-seeking activity,8 deductions for state and local taxes (hereinafter “SALT”) are itemized deductions9 for individual taxpayers who elect to itemize rather than take their standard deduction.

The Tax Cuts and Jobs Act of 2017 (hereinafter “TCJA”) added § 164(b)(6), which applies to individuals and disallows a deduction for foreign real property taxes, and limits the aggregate deduction for state and local real property and personal property taxes, and state and local income tax (or general sales tax, if elected), to a maximum of $10,000 per taxable year ($5,000 for a married taxpayer filing a separate return), for the 2018 to 2025 taxable years.10 

The $10,000 limitation does not apply to an individual taxpayer’s state, local and foreign real and personal property taxes, or to state and local sales tax, if paid or accrued in carrying on a trade or business or in connection with a profit-seeking activity under § 212.11 

The TCJA nearly doubled the standard deduction for tax years 2018 through 2025,12 and suspended the personal exemption for that same period of time.13 The increased standard deduction was projected to reduce the number of taxpayers who itemized their deductions from approximately 46.5 million taxpayers in 2017 to just over 18 million taxpayers in 2018.14 While the increased standard deduction simplifies the tax-filing process for taxpayers, the Tax Policy Center estimated that the percentage of taxpayers who would receive a tax benefit, or reduction in their tax liability, due to the SALT deduction fell from 25% in 2017, before the TCJA took effect, to 10% in 2018, as a result of the TCJA changes.15

III. The Charitable deduction workaround

Before the enactment of the TCJA, many states allowed taxpayers to make donations to “state governments or to state-government sponsored programs,” entitling those taxpayers to a state tax credit, which reduced their state tax liability.16 The taxpayer also received a charitable deduction for federal tax purposes, pursuant to § 170(a), for the full amount of the donation.17 Those donations supported “natural resource preservation, private school tuition scholarships, college financial aid, shelters for victims of domestic violence,” and other state programs.18

Due to concerns that individuals would use these tax credit programs to circumvent the § 164(b)(6) $10,000 limitation on state and local tax deductions through the use of § 170(a) charitable deductions, Internal Revenue Notice 2018-54 announced the Treasury Department and the IRS’s intention to propose regulations to address the federal tax treatment of these programs.19 On Aug. 27, 2018, Treasury issued proposed regulations providing that taxpayers who made a charitable donation and were entitled to a state or local tax credit as a result must reduce their charitable deduction under § 170(a) by the state or local tax credit, since it “constitutes a return benefit, or quid pro quo.”20 

The Treasury Department acknowledged the disadvantage imposed on taxpayers making a donation and receiving a state tax credit that reduced their federal charitable deduction, versus a taxpayer who paid their state tax liability in full and could deduct those payments pursuant to § 164(a).21 To address this issue, the Department of Treasury and the IRS announced a safe harbor rule,22 which allows individuals who itemize and make a charitable donation that entitles them to a state tax credit to treat the portion of the donation that is disallowed as a deduction under § 170(a) as a payment of state or local taxes for purposes of § 164(a), entitling them to the SALT deduction, subject to the $10,000 limit.23 Treatment of the disallowed donation as payment of state and local tax under § 164(a) applies to the taxable year the donation was made, to the extent the state tax credit reduced the taxpayer’s state tax liability, either in the year of payment or for the preceding year. If the state tax credit is not fully utilized to offset state tax liabilities for the taxable year in which the donation was made, or tax liabilities for the preceding year,24 then excess credits carried forward to future tax years that reduce state tax liabilities may be treated as a payment of state or local taxes.25 Finally, the safe harbor requires that the charitable contribution be cash or a cash equivalent.26 

IV. The payroll tax deduction workaround

Another means of circumventing the $10,000 deduction limit on state and local taxes is for states to increase payroll taxes paid by employers, and offset that tax increase either by reducing the revenues collected through state income taxes, or by providing an offsetting tax credit to employees.27 Employers subject to the tax increase would deduct their payroll taxes as an ordinary and necessary trade or business expense under § 162(a),28 and their employees’ reduced after-tax income would be offset by the reduction in their income tax liability.29 

This proposal raises concerns, including: (1) the reduction in employees’ take-home pay, and how it would address preexisting fixed contract or compensation arrangements between employers and their employees; (2) the ability of the state to increase payroll taxes sufficiently to balance out reduced income tax receipts; and (3) the rise in payroll taxes increasing tax regressivity by imposing a disproportionate tax burden on lower-paid workers.30 

V. Internal Revenue Notice 2020-75

Internal Revenue Notice 2020-75 announced the Department of Treasury and the Internal Revenue Service’s intention to issue proposed regulations clarifying that partnerships and S corporations can deduct state and local income taxes in calculating their non-separately stated income or loss,31 for the taxable year in which those taxes were paid, and thereby avoid the $10,000 limitation applicable to individual taxpayers under § 164(b)(6).32 The entity-level tax also reduces the partner’s distributive share and the S corporation shareholder’s pro rata share of pass-thru income.33 The proposed regulations apply to entity-level state or local tax payments made on or after Nov. 9, 2020, and also to tax payments made after Dec. 17, 2017, and before Nov. 9, 2020, if made pursuant to a law enacted prior to Nov. 9, 2020.34

IRC § 702(a)(8) requires that partners include their distributive share of partnership non-separately stated income or loss in calculating their taxable income. IRC § 1366(a)(1)(B) requires that S corporation shareholders include their pro rata share of S corporation non-separately stated income or loss in calculating their taxable income. Non-separately stated income or loss includes all income, gains, losses or deductions of the partnership or S corporation other than items that “if separately taken into account by any [partner or] shareholder could affect the [partner’s or] shareholder’s tax liability for that taxable year differently than if [they] did not take the item into account separately.”35 Non-separately stated items include ordinary income, gains, losses and deductions.36 

The tax treatment announced in Notice 2020-75 is supported by Rev. Rul. 58-25, which involved a city ordinance that imposed an earned income tax on the net profits of unincorporated businesses and on city residents’ shares of net profits from unincorporated trades or businesses.37 Rev. Rul. 58-25 relied upon Regulation § 1.62-1(d), which distinguished between taxes “directly attributable to a trade or business or to property from which rents or royalties are derived,” such as property taxes, which are deductible in computing adjusted gross income, as compared to taxes that are remotely connected to the trade or business, such as “State taxes on net income,” which are treated as itemized deductions.38 

Rev. Rul. 58-25 provides the basis for using the entity-level state or local tax payment in calculating the entity’s non-separately stated income or loss, which is reflected in the partner’s or S corporation shareholder’s distributive or pro rata share of non-separately stated income or loss.39 

VI. Massachusetts' Pass-through entity workaround

On Sept. 30, 2021, Chapter 63D, titled “Taxation of Pass-Through Entities,” took effect in Massachusetts. Chapter 63D applies to taxable years beginning on or after Jan. 1, 2021, and allows an “eligible pass-through entity,” which includes S corporations, partnerships and LLCs that are treated as an S corporation or partnership for federal tax purposes, to elect to pay an excise of 5% on the pass-through entity’s income that is allocable to and included in the taxable income of the partner, S corporation shareholder or LLC member.40 The partner, S corporation shareholder or LLC member, referred to as a “qualified member,” is allowed a refundable credit for the tax imposed under Chapter 63D, reducing their state personal income tax liability.41 The credit is equal to the qualified member’s proportionate share of the tax due and paid by the pass-through entity under Chapter 63D, multiplied by 0.9.42 The credit is allowable for the qualified member’s taxable year in which the taxable year of the pass-through entity ends.43 

Chapter 63D does not apply to any taxable year in which the $10,000 limitation on state or local taxes under IRC sec. 164(b)(6) is not applicable, due to its expiration, or otherwise.44 

The Chapter 63D excise is in addition to any other taxes applicable to the pass-through entity under Massachusetts law, and is due and payable on the entity’s original filed tax return, at the same time as the partnership information return or a corporate excise return.45 

Collection of the tax is subject to the administrative provisions of M.G.L. ch. 62C.46 

The election by the pass-through entity to pay the excise under Chapter 63D is made on an annual basis, and is irrevocable for the year in which the election is made.47 All partners, S Corporation shareholders and LLC members are bound by the election for the taxable year in which it is in effect.48 

The commissioner of the Department of Revenue is required to issue regulations to provide guidance on complying with Chapter 63D, and that may also address: (i) the allowance of the credit to qualified members with income from eligible pass-through entities that also have income from eligible pass-through entities; (ii) Chapter 63D’s applicability to estates and trusts; and (iii) required estimated payments of the Chapter 63D excise by eligible pass-through entities and their qualified members, consistent with Chapter 62B.49 

VII. Conclusion

The SALT deduction limit under § 164(b)(6) added complexity to the tax code, and to state-level legislation, as the states attempt to provide workarounds to their residents. Keep in mind that § 164(b)(6) expires at the end of 2025, which raises questions as to what changes we should anticipate in the future. In addition, despite state attempts to provide workarounds for their residents, the relief provided by the workarounds is not applicable to all taxpayers who are impacted by the $10,000 deduction limit. 

Wilton B. Hyman is the vice chair of the Massachusetts Bar Association Taxation Law Section Council and a professor at New England Law | Boston.

1. Other changes affecting individuals during the 2018-2025 tax years include: limiting the mortgage interest deduction on principal residences to $750,000 of acquisition indebtedness (instead of $1,000,000) incurred after Dec. 15, 2017; disallowing miscellaneous itemized deductions, such as unreimbursed employee trade or business expenses, tax preparation expenses and investment-related expenses; and limiting personal casualty losses, except in federally declared disasters.

2. Richard Rubin, “Democrats and Affluent Suburbs Join to Fight Tax-Break Cap,” WALL STREET JOURNAL, June 25, 2019, at

3. Personal property taxes are annual exactions imposed on personal property, based on its value. IRC § 164(b)(1). § 164(a)(3) allows a deduction for “state and local, and foreign, income, war profits and excess profits taxes.” 

4. H. Report No. 115-466 (1st Sess., 2017) 259. § 164(a)(4) also allows a deduction for generation-skipping taxes (GST) “imposed on income distributions.”

5. § 164(b)(2).

6. General sales taxes are taxes imposed at a single rate, at retail, on a broad range of items, such as food, clothing and motor vehicles. IRC § 164(b)(5)(B). 

7. IRC § 164(a).

8. IRC § 62(a)(1), (2), (4).

9. IRC § 63(b), (d), (e).

10. § 11042, Pub. L. No. 115-97; § 164(b)(6)(B) also includes state and local war profits and excess profits taxes, for purposes of the $10,000 limitation.

11. § 164(b)(6); “In the case of State and local income taxes, the deduction is an itemized deduction notwithstanding that the tax may be imposed on profits from a trade or business.” H. Report No. 115-466 (1st Sess., 2017) 259.

12. IRC § 63(c)(7); H.R. 1, “Tax Cuts and Jobs Act,” § 11021.

13. IRC § 151(d)(5); H.R 1, “Tax Cuts and Jobs Act,” § 11041.

14., at 6.


16. Kamin, Gamage, Glogower, Kysar, et al, “The Games They Will Play: Tax Games, Roadblocks, and Glitches Under the 2017 Tax Legislation,” 103 MINN. L. REV. 1439, 1477-1481 (2019); Charitable tax credits available in Massachusetts include donations of certified land to a public or private conservation agency, M.G.L. ch. 62, § 6(p) and M.G.L. ch. 63, § 38AA; and low-income housing tax credits, M.G.L. ch. 62, § 6I 1(a), (b)(4), (c)(1) and (c)(3). Bankman, et al, “Caveat IRS: Problems with Abandoning the Full Deduction Rule,” 88 STATE TAX NOTES 547, 573. 

17. I.R. Notice 2018-54. “Under current law, a donor is not required to reduce the amount of a federal charitable contribution deduction by the value of state tax benefits generated by the gift,” Bankman, et al, “State Responses to Federal Tax Reform: Charitable Tax Credits,” 83 STATE TAX NOTES 641-643.

18. Bankman, et al, “State Responses to Federal Tax Reform: Charitable Tax Credits,” 83 STATE TAX NOTES 641, 642.

19. 2018-24 I.R.B. 750.

20. 83 FR 43563; IRC reg. § 1.170A-(h)(3)(i). I.R Notice 2019-12, p. 3. 

21. I.R. Notice 2019-12, p. 5.

22. I.R. Notice 2019-12, p. 6.

23. Id.; IRC reg. § 1.164-3(j)(1), (3). 

24. IRC reg. § 1.164-3(j)(1).

25. IRC reg. § 1.164-3(j)(2).

26. IRC reg. § 1.164-3(j)(4).

27. Kamin, Gamage, Glogower, Kysar, et al, “The Games They Will Play: Tax Games, Roadblocks, and Glitches Under the 2017 Tax Legislation,” 103 MINN. L. REV. 1439, 1481 (2019); New York State recently enacted an optional payroll tax workaround for employers, “The Employer Compensation Expense Program,” N.Y. TAX LAW §§ 850-857.

28. Kamin, Gamage, Glogower, Kysar, et al, “The Games They Will Play: Tax Games, Roadblocks, and Glitches Under the 2017 Tax Legislation,” 103 MINN. L. REV. 1439, 1481 (2019).

29. Id. at 1482.

30. Id. 

31. IRC § 702(a)(1)-(7), which applies to partners, and § 1366(a)(1)(A) both require partners and S corporation shareholders to report their distributive share of partnership tax items or S corporation tax items, respectively. Those sections require that certain partnership or S corporation tax items be separately stated, so they cannot be aggregated with other entity-level tax items before they pass through to the partners or S corporation shareholders, due to those items affecting partners and shareholders differently, based on their own individual tax circumstances. Examples of separately stated items include short-term capital gains or losses, long-term capital gains or losses, and charitable deductions, each of which may have a different tax impact to a partner or S corporation shareholder, depending upon whether they have offsetting capital gains or losses, or sufficient adjusted gross income, that would allow them to avoid tax on the gains, or to deduct the loss or charitable deduction.

32. I.R. Notice 2020-75, §§ 1, 3.02(3)-(4).

33. H.R. Rep. No. 115-466, at 260 n. 172 (2017).

34. I.R. Notice 2020-75, § 4.

35. IRC reg. § 1.1366-1(a)(2).

36. IRC § 64 defines “ordinary income” as including gain from the sale or exchange of property that is not a capital asset or sec. 1231 property, and IRC § 65 defines “ordinary loss” as including losses from a sale or exchange of property that is not a capital asset.

37. Rev. Rul. 58-25, 1958-1, C.B. 95.

38. See IRC Regulation § 1.62-1T(d).

39. I.R. Notice 2020-75, §§ 2.01(5), 3.02(3).

M.G.L. ch. 63D, §§ 1, 2. The technical term for the pass-through entity’s income that is subject to the excise is “Qualified income taxable in Massachusetts,” which is defined as “the income of an eligible pass-through entity determined under chapter 62 allocable to a qualified member and included in the qualified member’s Massachusetts taxable income under said chapter 62.” M.G.L., ch. 63D, § 1.

41. M.G.L. ch. 63D, §§ 1, 2. A “qualified member” includes a natural person, or a trust or estate subject to tax under § 10 of Chapter 62, and includes state residents, nonresidents or part-year residents. M.G.L. ch. 63D, § 1; Jason Zorfas, “Massachusetts enacts an elective tax on pass-through entities, Sept. 30, 2021, at, Note 4.

42. M.G.L. ch. 63D, § 2.

43. Id. 

44. M.G.L. ch. 63D, § 3.

45. M.G.L. ch. 63D, § 4.

46. M.G.L. ch. 63D, § 5.

47. M.G.L. ch. 63D, § 6.

48. Id. 

49. M.G.L. ch. 63D, § 7.