The New York state budget deal announced yesterday includes a workaround of the temporary federal limit on state and local tax deductions (the SALT cap). The provision was part of Gov. Cuomo’s initial budget proposal in January, and it comes at a time when many Democrats are calling on Pres. Biden to include the elimination of the SALT cap as part of his recently announced infrastructure proposal.

The SALT cap was added to the Internal Revenue Code as part of the Tax Cuts and Jobs Act (TCJA) in 2017. It is scheduled to lapse after 2025. Until then, however, joint filers may not claim more than $10,000 in itemized deductions for state and local tax payments for purposes of determining their federal income tax liability. This can be burdensome for New York residents, especially after the budget’s tax rate increases are enacted.

Last November, the IRS issued guidance in which it described an approved form of workaround based upon an entity-level state tax.

The New York budget provision is modeled on the above-referenced IRS notice, and would allow pass-through businesses to pay taxes at the entity level. The entity-level tax would be offset by a corresponding individual income tax credit.


You may recall that, prior to the enactment of the TCJA, individual taxpayers were permitted a deduction for these taxes, whether or not incurred in a taxpayer’s trade or business or activity for the production of income. [1] Property taxes were allowed as a deduction in computing adjusted gross income if incurred in connection with property used in a trade or business; otherwise they were an itemized deduction. In the case of state and local income taxes, the deduction was an itemized deduction notwithstanding that the tax may be imposed on profits from a trade or business.

Under the TCJA – for taxable years beginning after December 31, 2017, and beginning before January 1, 2026 [2] – in the case of an individual, the itemized deduction for the aggregate of (i) state and local property taxes not paid or accrued in carrying on a trade or business, or in conducting an activity for the production of income, [3] and (ii) state and local income taxes (or sales taxes in lieu of income taxes) paid or accrued in the taxable year, is limited to $10,000 ($5,000 for a married taxpayer filing a separate return). [4]


You may also recall that, shortly after the enactment of the SALT cap, many high-tax states (including New York) sought to overturn or somehow circumvent the limitation.

These early efforts were not successful but, in November of 2020, the IRS approved of an arrangement under which a state would impose a mandatory or elective entity-level income tax on partnerships and S corporations that do business in the state, or that have income derived from sources within the state.

According to the IRS, this entity-level income tax would be deductible by partnerships and S corporations in computing their non-separately stated income or loss; in this way, the entity’s tax payment would be reflected in an individual partner’s or shareholder’s distributive or pro-rata share of non-separately stated income or loss reported on a Schedule K-1. This indirect owner-level tax benefit would not be taken into account, the IRS indicated, in applying the SALT deduction limitation to the individual partner or shareholder. [5]

Of course, this workaround is limited – it only applies to partners in a partnership and to shareholders of an S corporation. It does nothing, for example, to reduce the impact of the cap on higher-paid employees who live or work in high tax states, including New York.

Many observers believe that the elimination or increase of the SALT cap may be difficult to achieve at the federal level because it would deliver a significant tax benefit to wealthy Americans while doing next to nothing for most other taxpayers.

New York’s Budget

Governor Cuomo must have anticipated these risks and, so, the current budget introduced an elective “pass-through entity tax” similar to the workaround approved by the IRS, described above. The elective tax will be available only to partnerships and S corporations, all the owners of which are individuals.

As originally proposed by the Governor, the tax would be imposed at the rate of 6.85 percent [6] upon the adjusted net income of an electing pass-through entity that is doing business in New York, to the extent such income is allocable to New York.

The pass-through entity’s partners or shareholders would be entitled to a credit against their New York personal income tax liability based upon their profit percentage of the partnership or their pro rata share of the S corporation, and the amount of entity tax paid by the partnership or S corporation, as the case may be. [7]

A similar credit would be available to a resident partner or shareholder for their share of any pass-through entity tax imposed by another state upon the entity’s income derived from that state. In this way, the partners and shareholders will be permitted to indirectly deduct the SALT taxes paid by their pass-through entity.

The final text of the budget bill has not yet been released. Stay tuned for updates. In the meanwhile, it would behoove any pass-through entity doing business in New York to begin considering the impact of the elective tax upon its owners.


[1] In determining an individual’s alternative minimum taxable income, no itemized deduction for property, income, or sales tax was allowed.

[2] Yes, this is yet another of the TCJA changes that sunsets after 2025.

[3] Thus, under the provision, in the case of an individual, state and local property taxes, and state and local sales taxes, are not subject to the SALT cap limitation when paid or accrued in carrying on a trade or business, or an activity for the production of income.

[4] Sec. 11042 of the TCJA and sec. 164 of the Code. The “State and Local Tax,” or SALT, Cap.

[5] IRS Notice 2020-75.

[6] The highest New York tax rate applicable to individuals, disregarding the “temporary” surcharge taxes.

[7] The electing pass-through entity will be liable for the tax in the first instance; in addition, the partners or shareholders of the pass-through entity will be jointly and severally liable for the tax.