Partnerships & S Corps with Income Sourced to NJ Can Deduct State Income Taxes

The IRS issued Notice 2020-75 clarifying that state and local income taxes imposed on and paid by a Partnership or an S Corporation are deductible by the Partnership or S Corporation in computing taxable income for the year of the payment. The IRS intends to issue proposed regulations on the subject.

Some state and local jurisdictions, such as New Jersey, have enacted or are considering enacting entity-level income tax on Partnerships and S Corporations sometimes with a corresponding credit, deduction, or exclusion for the owners. The proposed regs will clarify that Specified Income Tax Payments are deductible by Partnerships and S Corporations in computing their non-separately stated income or loss.

The Partnership or S Corporation can deduct Specified Income Tax Payments in computing taxable income for the year the payment is made. The Specified Income Tax Payments will be reflected in a partner’s or a shareholder’s distributive or pro-rata share of non-separately stated income or loss.

Specified Income Tax Payment:

• (1) is not an item of deduction that a partner or shareholder considers separately in determining its own federal income tax liability; and
• (2) is not considered in applying the SALT deduction limitation to any individual partner or shareholder.

Effective for taxable years beginning on or after January 1, 2020, New Jersey pass-through entities may elect to pay a Pass-Through Alternative Income tax due on the sum of each of the member’s share of income sourced to New Jersey.  Each member’s share of the entity tax can be claimed as a credit for tax paid by the pass-through entity on their share of New Jersey sourced income.

An individual’s federal state and local income tax (SALT) deduction is limited to $10,000. The SALT deduction includes state income taxes.  The New Jersey Pass-Through Alternative Income Tax payment paid by the S corporation or partnership is not subject to the $10,000 SALT limitation.

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Taking advantage of the New Jersey Pass-Through Business Alternative Income Tax Act election requires filing an election.  Please contact us today to discuss the New Jersey Pass-Through Alternative Income tax and making the election.