How Alabama Businesses Can Bypass the SALT Deduction Cap

December 12, 2024
SALT deduction cap workaround Alabama

Understanding the SALT Cap Deduction Workaround for Businesses in Alabama

The federal State and Local Tax (SALT) deduction cap, enacted as part of the Tax Cuts and Jobs Act (TCJA) in 2017, has created challenges for taxpayers in high-tax states.  This cap limits the amount individuals can deduct for state and local taxes to $10,000, significantly impacting those in states with higher property and income taxes.  However, several states, including Alabama, have implemented workarounds that allow certain businesses to bypass this limitation.  Here, we’ll explore Alabama’s approach to the SALT cap deduction workaround and how it can benefit business owners.

What Is the SALT Deduction Cap?

The SALT deduction cap is a provision in the TCJA that limits individual taxpayers to a $10,000 deduction for state and local property, income, or sales taxes on their federal income tax returns.  While this policy was aimed at increasing federal tax revenue, it disproportionately affects taxpayers in states with high income and property taxes.  For business owners in these states, the limitation can result in a higher federal tax burden.

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Alabama’s SALT Cap Workaround

In response to the SALT cap, Alabama introduced a workaround through the Pass-Through Entity Tax (PTET) election.  This strategy allows certain pass-through entities, such as S corporations and partnerships, to pay state income taxes at the entity level rather than passing them through to individual owners.  Because entity-level taxes are not subject to the SALT deduction cap, this approach enables business owners to fully deduct these taxes on their federal returns.

How It Works

  1. Election Process: Alabama businesses must elect to be taxed at the entity level.  This election must be made annually and is binding for the tax year.
  2. Payment of Entity-Level Taxes: Once the election is made, the business pays Alabama state income tax directly on its income.
  3. Federal Deduction: The business can deduct the full amount of state taxes paid at the entity level on its federal tax return.  This effectively circumvents the $10,000 SALT cap imposed on individual taxpayers.
  4. Credits for Owners: Owners of the pass-through entity receive a corresponding credit on their Alabama state income tax return, avoiding double taxation.

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Eligibility and Requirements

To utilize Alabama’s PTET election:

  • The business must be organized as a pass-through entity (S corporation or partnership).
  • The election must be made by the due date (including extensions) of the entity’s tax return.
  • All owners must agree to the election.

It’s important to consult with a tax professional to ensure compliance with these requirements and to evaluate whether the election is beneficial for your specific circumstances.

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Advantages of the Workaround

  1. Increased Federal Tax Deductions: The primary benefit of the PTET election is the ability to deduct state taxes without being subject to the $10,000 SALT cap.
  2. Tax Savings for Business Owners: By reducing taxable income at the federal level, business owners can potentially lower their overall tax liability.
  3. Simplified Tax Planning: With the ability to deduct state taxes at the entity level, businesses can achieve more predictable tax outcomes.

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Potential Drawbacks

While the PTET election offers significant benefits, it may not be suitable for all businesses.  Some potential drawbacks include:

  • Administrative Complexity: Electing and complying with the PTET requires careful record-keeping and coordination among all owners.
  • State-Specific Rules: Businesses operating in multiple states must navigate different PTET provisions and ensure compliance across jurisdictions.
  • Impact on Other Deductions: Depending on a business’s structure and financial situation, the election might affect other deductions or tax strategies.

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Considerations for Alabama Business Owners

If you’re a business owner in Alabama, evaluating the PTET election requires a comprehensive review of your tax situation.  Consider the following:

  1. Type of Entity: Only S corporations and partnerships are eligible for the PTET election.  Sole proprietors and C corporations do not qualify.
  2. Taxable Income Levels: The benefit of the workaround depends on the amount of state taxes your business pays and your federal tax bracket.
  3. Coordination with Owners: All owners must consent to the election, making it essential to align interests and ensure mutual agreement.
  4. Consultation with Professionals: Tax laws are complex and frequently change.  Working with a CPA or tax advisor ensures compliance and optimization of potential savings.

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Future of the SALT Cap

The SALT cap is scheduled to expire after 2025 unless Congress acts to extend it.  However, the continuation of state-level workarounds, like Alabama’s PTET election, underscores their importance as tools for mitigating federal tax burdens in the current legislative environment.

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Conclusion: Consider Making the Election

Alabama’s SALT cap deduction workaround provides a valuable opportunity for business owners to reduce their federal tax liability.  By electing to pay state taxes at the entity level, pass-through entities can bypass the $10,000 SALT deduction cap and achieve significant tax savings.  However, this strategy requires careful consideration and professional guidance to maximize its benefits and ensure compliance with state and federal regulations.  If you’re considering this option for your Alabama-based business, consult with a tax advisor to determine whether the PTET election aligns with your financial goals and tax planning strategy.

Have questions?  Contact a qualified tax professional to see if electing to have your state and local taxes moved to the entity level is the right move for you.

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Question: If my business is set up as a single-member LLC taxed as a disregarded entity, can I still use the entity-level election in Alabama to avoid the SALT cap?

Answer: Generally no — the workaround requires that the business be a pass-through entity (PTE) such as an S-corporation or partnership (or an LLC treated as one) that can make the entity-level election. An LLC taxed as a disregarded entity (sole proprietor) doesn’t qualify for the entity-level election in most states, because the owner pays tax personally on the business income and cannot shift the state tax to the entity level. For Alabama, the guidance indicates eligible “Pass-Through Entities” that make the election via Form PTE-E. If you are a sole proprietor or single-member LLC taxed as disregarded, you would need to evaluate whether converting to an eligible PTE structure makes sense — but the election alone won’t cover you as a sole proprietor.

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Question: Does making the entity-level election in Alabama impact how non-resident owners are taxed or how credits work for out-of-state partners?

Answer: Yes — this can become a nuanced issue. When a PTE makes the election at the entity level in Alabama, the tax is paid by the entity and owners receive a credit or reduction on their personal returns for their share of the tax. But for non-resident owners in other states, they may not always get full credit in their home state for the entity-level tax paid in Alabama, meaning they could face double taxation or reduced benefit. Also, the interplay between the owner’s state of residence and Alabama’s credit rules should be carefully reviewed. In short: if you have partners or members who live outside Alabama, you’ll want to check how their home state treats entity-level taxes and whether their state allows a credit or comp offset for the Alabama PTE tax.

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Question: If Congress changes the federal SALT cap or the rules for entity-level elections going forward, what happens to a PTE in Alabama that already made the election for a tax year?

Answer: When tax laws change, the effect on PTE elections depends on timing and whether the election is irrevocable for that year. Generally the election for a tax year is binding for that year once made and may commit the entity (and therefore its owners) to that treatment. If Congress later modifies the federal SALT cap or disallows the workaround, the PTE strategy may still stand because the entity made a valid election under state law for that year. However, future years may require re-assessment of eligibility and risk. Some states’ regimes are tied to the federal cap; if the federal cap goes away, the state election might sunset. According to commentary, Alabama’s PTE regime may not be automatically tied to the federal cap. For business owners, that means you should treat the current election as subject to legislative risk, maintain documentation, and work with your tax advisor each year to monitor changes.

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