CBA Record January-February 2022


Pass Some SALT: Breaking Down the New Illinois Pass-through Entity Tax Election

By Nick Aylmer, CPA & Ted Kontopoulos I n August 2021, Illinois Governor J.B. Pritzker signed a bill enacting a state and local tax (SALT) deduction cap workaround, S.B. 2531, 102d Gen. Assemb., Reg. Sess. (Ill. 2021) (codified at 35 ILCS 5/201(p)). The workaround, known as a pass-through entity-level tax election (PTE), effectively allows partners, owners, and shareholders of most Illinois pass-through businesses to avoid a federal deduction cap on SALT payments. Exam- ples of pass-through businesses include, but are not limited to, partnerships, lim- ited liability companies, and subchapter S corporations. Because law firms are typi- cally taxed as pass-through businesses, this bill impacts the federal and Illinois state income taxation of nearly every Chicago law firm. This article offers some factors for Illinois law firms to consider regarding the efficiency of their income tax positions, particularly with respect to relief from the federal SALT cap.

income tax along with a nearly unlimited SALT deduction for “all national, state, or local taxes assessed upon the property, from which the income [subject to tax] is derived.” Act of Aug. 5, 1861, ch. 45, § 49, 12 Stat. 292, 309. Although that tax expired in 1872, Congress restored it in 1894, along with the SALT deduction. In 1895, the United States Supreme Court struck down the 1894 tax, holding that it violated the then- constitutional prohibition against direct taxes not apportioned among the states in proportion to their relative populations. Pollock v. Farmers’ Loan &Tr. Co. , 158 U.S. 601, 637 (1895); U.S. Const. art. I, § 9, cl. 4. Ratification of the Sixteenth Amend- ment in 1913 effectively overruled the Supreme Court’s holding in Pollock and resolved this issue, and Congress reinstated the federal income tax and reintroduced the SALT deduction for “all national, State, county, school, and municipal taxes paid within the year, not including those assessed against local benefits.” Act of Oct. 3, 1913, ch. 16, § II(B), 38 Stat. 114, 167. From 1913 to today, some form of the SALT deduction has existed under federal tax policy. Until 1964, the tra- ditional policy for the SALT deduction was that all state and local tax payments were deductible unless specifically disal- lowed. In 1964, Congress amended the deduction by providing that only certain

enumerated types of SALT payments were deductible and by disallowing deductions for any other SALT payments. Pub. L. No. 88-272, 78 Stat. 19, 40–42, § 207 (1964). After introducing additional limitations in 1986 and 1990, Congress reinstated significant SALT deduction benefits in 2004 under the American Jobs Creation Act. Pub. L. No. 108-357, 118 Stat. 1418, § 501 (2004). The reinstatement, however, came with a catch: taxpayers had to choose between deducting either state and local sales taxes or state and local income taxes. From 2004 until 2017, eligible individual taxpayers could always elect to deduct two of three types of SALT payments: (1) all state and local real and personal property taxes as well as (2) either (i) all state and local income taxes, or (ii) all state and local sales taxes. A Novel Approach In a novel approach, the 2017Tax Cuts and Jobs Act (TCJA) imposed a $10,000 SALT Cap for individual taxpayers. Pub. L. No. 115-97, 131 Stat. 2054, § 11042 (2017); 26 U.S.C. § 164(b)(6). The primary policy rationales for the SALT Cap were to: (1) reduce what amounted to federal subsi- dization of high-tax states; (2) encourage financially irresponsible states to make their budgets sustainable through methods other than tax rate increases; and (3) pay for various federal tax rate cuts, such as the

Tax History A brief history of federal tax public policy is helpful in illustrating SALT and its original purpose. The United States had no federal income tax at its founding. The federal government was entirely funded for its first few decades by tariffs and cus- toms duties. However, Civil War expenses rendered that approach unsustainable, and in 1861, Congress enacted the first federal

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