Pass-Through Entity Tax Elections for the Staffing Industry

One of the many changes to a tax code prescribed by the Tax Cuts and Jobs Act of 2017 (“the TCJA”) was the state and local tax cap. Specifically, individual taxpayers opting to itemize their deductions for federal personal income tax purposes would be subject a $10,000 cap on the deduction for state and local taxes (“the CAP”).

Since the passing of the TCJA, states have taken various measures to combat this unfavorable tax treatment and ease any additional burden. The most popular measure to date has been the enactment of pass-through entity taxes. As the TCJA only imposes the CAP on individual taxpayers, by imposing the tax at the entity level and offering partners/shareholders a credit, states haves created an effective workaround to the TCJA CAP.

When Connecticut, the first state to institute a workaround, enacted this tax, there was much uncertainty as to the validity of the federal deduction for these new entity taxes. On November 9, 2020, IRS Notice 2020-75 was released wherein the IRS insinuated that it would not challenge this deduction, thus creating increased clarity and opening the floodgates for more and more states to pass similar legislation.

Recently, New York and California have also added a voluntary CAP workarounds, joining Maryland, New Jersey, Oklahoma, Rhode Island, and Wisconsin. Many other states have legislation in the pipeline, creating an opportunity that warrants further monitoring.

With operations that often cross multiple state borders, the staffing industry is poised to benefit greatly from the new legislation. Additionally, with the COVID-19 pandemic creating an environment where employees are seemingly located in more states than ever, there is a possibility of increased state income tax nexus. Close examination of each staffing company’s unique circumstances is vital in determining the potential benefit from opting-in to the new tax regimes available.

These multi-state operations further complicate the decision to pay entity taxes. Amongst other considerations, the interplay between rules in the resident state of the business owners and the entity taxes in the states where income is derived should be appropriately analyzed. As many states do not allow a credit for entity taxes paid, there is a possibility of unintended negative tax consequences from electing to pay such taxes, depending upon the resident state of business owners.

The CAP, in addition to other individual tax changes of the Act, are scheduled to expire at the end of 2025. Furthermore, the CAP could be repealed sooner than that. Thus, the workarounds discussed herein may be a temporary solution. That said, there is potential for tremendous short-term tax savings and even long-term opportunities. All nuances to the rules must be flushed out and considered before electing into an entity tax regime, but the benefits can certainly be worth the efforts.

Please contact a Citrin Cooperman advisor for more information on this opportunity.