Page 584 - TaxAdviser_2022

STATE & LOCAL TAXES

future. Alternatively, some states require deficit restoration obligation or quali-
the election to be made on a timely filed fied income offset. 15
state tax return. While partnerships do allow for One significant
For example, New York requires the special allocations, S corporations are question that remains
2022 election to have been made by required to allocate items of expense on unanswered by the
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Sept. 15, 2022, while California does a per share, per day basis. This require-
not deem a binding 2022 election to ment forces S corporations to allocate notice is whether
have been made until a timely return is the deduction associated with the SITP refundable PTE tax
filed, resulting in the election not being to S corporation shareholders pro rata,
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made until tax year 2023. If the elec- regardless of whether every shareholder credits are includible
in income under the
tion is not binding for the tax year it receives a correlating state income tax
relates to, other facts and circumstances credit or income exclusion related to Sec. 111 tax-benefit
may allow for the liability to become the SITP. If disproportionate benefit is
rule.
fixed, including estimated tax payments provided to select shareholders, the use
or a board of directors’ resolution. of loan arrangements may be required
Lastly, a taxpayer is only permitted to ensure the S corporation is not being business. However, Temp. Regs. Sec.
to adopt the recurring-item exception depleted by SITPs made to the detri- 1.62-1T(d) provides that taxes on net
as part of its method of accounting in ment of S corporation shareholders income are not deductible even though
the first tax year in which the item was not receiving a state income tax credit the taxpayer’s income is derived from
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incurred. or exclusion. the conduct of a trade or business. This
concept is reflected when real estate
How should an SITP Is an SITP deductible in investors are able to deduct real property
federal deduction be arriving at federal AGI? taxes paid in relation to rental property
allocated among the owners? The distinction between “above the as an above-the-line deduction, while
After determining the amount of line” and “below the line” deductions is the state income taxes paid in relation to
an SITP that is deductible at the particularly important when computing the rental property must be reported as
federal level, the next requirement is an individual taxpayer’s taxable income. an itemized deduction.
to allocate the deduction among the The concept of adjusted gross income The principle that SALT is not
PTE owners. (AGI) separates deductions into one of deductible in arriving at AGI is high-
For partnerships, the deduction can two categories: (1) a deduction in arriving lighted in a variety of cases, including
be specially allocated among the part- at AGI, or (2) an itemized deduction. Tanner, Strange, and Cutler. 17
ners, provided it meets the substantial- Generally, a deduction in arriving at AGI If state income taxes imposed on
economic-effect rules. Substantial (above the line) is more favorable than business income are not deducted above
effect is met if the economic burden is an itemized deduction (below the line) the line, how does the IRS conclude
allocated to the partner who receives because of the various limitations that that such taxes imposed on a PTE can
the economic benefit. Economic ef- may apply to itemized deductions (e.g., circumvent the regulations and case law?
fect is met if the operating agreement the $10,000 cap on SALT deductions). In Notice 2020-75, the IRS highlighted
requires the maintenance of partner Generally, for SALT to be classified Rev. Rul. 58-25, which held that “a
capital accounts in accordance with the as an above-the-line deduction, it must Cincinnati, Ohio tax imposed upon and
principles of Regs. Sec. 1.704-1(b)(2)(iv), be directly, and not remotely, connected paid by a partnership on the net profits
partner distributions upon liquidation with the conduct of a trade or business. of the partnership’s business conducted
are required to be made based on posi- For example, property taxes imposed in Cincinnati was deductible in comput-
tive Sec. 704(b) capital accounts, and on real property can be directly con- ing the taxable income or loss of the
the partnership agreement contains a nected with the conduct of a trade or partnership.”

12. A one-time extension of the general requirement that the election may 14. Regs. Sec. 1.461-5(d)(1).
be made between Jan. 1 and March 15. See N.Y. Dept. of Taxation and 15. Regs. Sec. 1.704-1(b)(2).
Finance, Notice: Extended Deadline to Opt Into the New York State Pass- 16. Sec. 1377(a)(1).
Through Entity Tax (PTET) for 2022 (Aug. 10, 2022), and N.Y. Tax Law 17. Tanner, 45 T.C. 145, 151 (1965); Strange, 270 F.3d 786 (9th Cir. 2001); and
§860(h). Cutler, T.C. Memo. 2015-73.
13. Cal. Rev. & Tax. Code §19900(d).

42 November 2022 The Tax Adviser