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Changes to Maryland Pass Through Entity Taxation Election

Since the enactment of the Tax Cuts and Jobs (TJCA), business owners could deduct $10,000 of state and local taxes as an itemized deduction. Maryland has other plans.

Introducing the recently passed Maryland Senate Bill 523, which creates an elective federal state and local tax deduction limitation workaround. The new law will go into effective July 1, 2020, and will be applicable to tax years beginning after December 31, 2019.

Under the Tax Cuts and Jobs (TJCA), which went into effect January 1, 2018, state and local tax deductions were limited to $10,000 for individuals. What the new Maryland Senate Bill permits is the re-characterization of a non-deductible individual state income tax expense to a deductible state income tax expense for federal income tax purposes. This is a potentially large benefit to owners of pass-through entities owned and operated in Maryland. Eligible owners may now pay Maryland state taxes at the pass-through entity level and deduct as a federal expense. This means the limitations that would be imposed upon individuals under the TCJA are now a thing of the past. And Maryland isn’t the only state with this idea. States like Connecticut, Louisiana, New Jersey, Rhode Island and Wisconsin have also enacted similar legislation.

How does it work?

The pass through entity elects to pay the tax on the Maryland residents’ member, partner, or shareholders share of income. Those owners could then claim a credit on their Maryland income tax return based on their share of entity’s taxable income. This becomes a state tax expense now deductible on the federal pass through income tax return. It’s important to note that states in which the member is taxed is a bit confusing, but could lend to big benefits.

There are still a few areas of the new law requiring additional clarification and guidance. For instance, it is still unknown if this is an annual election or permanent election. We promise to update this article with more information as it becomes available.

Also, please note that this may not lend itself to the best overall tax benefit for all members of the pass through entity, so it is worthwhile to run the numbers before making the election. Do not hesitate to contact a member of our tax team with any questions you may have regarding this new law and how it may affect you.

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