SALT Cap Workarounds

• In Event: In Honor of Ronald C. Fisher and His Landmark Text on State and Local Public Finance: Is the US system of fiscal federalism too "SALTY"?

Abstract

The 2017 Tax Cuts and Jobs Act considerably limited federal deductions for state and local tax (SALT) payments, generally to $10,000 for individual taxpayers. This limitation particularly affected high-income taxpayers, as SALT liability highly correlates with income. In response, many states enacted passthrough entity tax (PTET) laws to facilitate a workaround to this limitation. PTETs effectively allow passthrough business owners to remit their state individual income taxes via their businesses, for which income taxes are fully deductible at the federal level. Because PTETs are not directly reported on federal income tax returns, it is difficult to measure the pervasiveness of these workarounds. To estimate workaround take-up, we use administrative business tax return data combined with a difference-in-differences research design. We compare aggregate tax deductions claimed by passthrough businesses (workaround payments or otherwise) in states with and without PTETs, before and after enactment of the laws. Our preferred specification is a triple-difference design, which further controls for tax deductions claimed by C corporations, which cannot elect to pay PTETs. This allows us to account for unobservable factors that may affect aggregate tax deductions differentially across states and years. By using the PTET workaround, we estimate that passthrough businesses deducted $73 billion of income taxes in 2024, translating to more than $15 billion in reduced federal revenue. Further, we find that nearly 80% of the workaround benefits flowed to the top 1% of the individual income distribution.

Authors

• Matthew Comey, matthew.comey@jct.gov

• William Gorman, Joint Committee on Taxation

• Brian Gallagher, Joint Committee on Taxation