Partnerships and S corps. can deduct state and local taxes

In a taxpayer-friendly development, the IRS said it would issue proposed regulations allowing S corporations and partnerships to deduct “specified income tax payments” paid to state and local governments above the line and not as passthrough items for partners and shareholders. Notice 2020-75 defines the specified income tax payments as any amount a partnership or an S corporation pays to a state, a political subdivision of a state, or the District of Columbia to satisfy its liability for income taxes imposed on the partnership or the S corporation.

The definition will exclude income taxes imposed by U.S. territories or their political subdivisions. This definition includes only income taxes described in Sec. 164(b)(2) for which Sec. 703(a)(2)(B) does not disallow a partnership a deduction, and those income taxes for which Sec. 1363(b)(2) does not disallow an S corporation a deduction.

These rules mean that specified income tax payments paid as state and local income taxes imposed on and paid by a partnership or an S corporation on its income are allowed as a deduction by the partnership or S corporation in computing its non–separately stated taxable income or loss for the tax year of payment. They are not passed through to the partners or shareholders, where they would be subject to the $10,000 limitation on state and local tax deductions enacted in the law known as the Tax Cuts and Jobs Act, P.L. 115-97.

Effective dates

The IRS did not provide a timetable for issuing the proposed regulations but said they will apply to specified income tax payments made on or after Nov. 9, 2020. The proposed regulations will also permit a deduction for payments made by a partnership or S corporation for tax years ending after Dec. 31, 2017, and before Nov. 9, 2020, if the specified income tax payment is made to satisfy the liability for income tax imposed on the partnership or S corporation pursuant to a law enacted before Nov. 9, 2020.

https://www.journalofaccountancy.com/news/2020/nov/partnerships-s-corps-deduct-state-local-taxes.html