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State Tax Credit Issues Raised by SALT Cap Workaround Legislation

Posted on Jan. 18, 2021
Andrew Appleby
Andrew Appleby
Walter Hellerstein
Walter Hellerstein

Walter Hellerstein is the Distinguished Research Professor Emeritus and the Francis Shackelford Professor of Taxation Emeritus at the University of Georgia Law School and is visiting professor at the Vienna University of Economics and Business and chair of the Tax Notes State advisory board. Andrew Appleby is an assistant professor of law at the Stetson University College of Law.

In this article, Hellerstein and Appleby examine issues arising from the IRS’s approval of state and local tax cap workarounds for passthrough entities.

Copyright 2021 Walter Hellerstein and Andrew Appleby.
All rights reserved.

I. Introduction

For tax years 2018 through 2025, the federal Tax Cuts and Jobs Act of 20171 limited the aggregate amount of itemized state and local tax deductions for federal personal income tax purposes to $10,000.2 To avoid the impact of this “SALT cap” insofar as it limited the personal income tax deductions of passthrough entity (PTE) owners for federal income tax purposes, several states adopted legislation imposing taxes directly on the PTEs’ incomes.3 The theory underlying the PTE tax legislation was that state income taxes paid by the PTE would be deductible from the PTE’s income and would correspondingly reduce individual PTE owners’ taxable distributive shares of passthrough income for federal personal income tax purposes without regard to the SALT cap, thereby working around the SALT cap.4 At the same time, however, to avoid imposing a double state tax burden on individual PTE owners who are now effectively paying state income tax at the entity level, states adopting SALT cap workaround legislation generally provide individual PTE owners with corresponding owner-level tax benefits, in the form of credits, deductions, and exemptions, regarding their state personal income taxes.5 In essence, the PTE tax legislation simply shifts the incidence of the tax to the entity instead of the individual to circumvent the federal SALT cap imposed on individuals.

After nearly three years of uncertainty over whether the Internal Revenue Service would embrace the theory underlying the states’ SALT cap workaround legislation, the IRS issued a notice in late 2020 essentially recognizing the deductibility of the state PTE taxes at the entity level for federal personal income tax purposes notwithstanding the provisions of the legislation designed to reduce the PTE owners’ state tax liability at the ownership level.6 The notice declared the IRS’s intent to “issue proposed regulations to clarify that 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 taxable year of payment.”7

The notice also recognizes that some jurisdictions “have enacted, or are contemplating the enactment of, tax laws that impose either a mandatory or elective entity-level income tax on partnerships and S corporations” and that “the jurisdiction’s tax law provides a corresponding or offsetting, owner-level tax benefit, such as a full or partial credit, deduction, or exclusion.”8 The notice further observes that “there is uncertainty as to whether entity-level payments made under these laws . . . must be taken into account in applying the SALT deduction limitation at the owner level.”9 The notice concludes that the tax payment by the PTE is deductible regardless of whether the imposition of the PTE tax is elective or whether PTE owners “receive a partial or full deduction, exclusion, credit, or other tax benefit that is based on their share of the amount paid” by the PTE “to satisfy its income tax liability” and that “reduces” the PTE owners’ “own individual income tax liabilities” under the state’s tax law.10

II. Tax Credit Issues in States With SALT Cap Workaround Legislation

While the deductibility of the states’ PTE taxes for federal income tax purposes now appears to be established, the existence (and, with the IRS’s blessing, possible proliferation) of PTE taxes may give rise to controversies analogous to those that have arisen in the past regarding the creditability of other states’ entity-level taxes on PTEs borne by resident PTE owners.11 Insofar as states have adopted their own PTE tax legislation and provided credits against the owners’ distributive share of the state’s entity-level taxes — as it appears that the states with PTE tax legislation effectively have — it would be hypocritical, and, in most cases, blatantly unconstitutional, for states to fail to provide a credit against other states’ PTE taxes borne by their resident owners. Indeed, it would be difficult to find a better example of an internally inconsistent tax regime than one that confined the credit for a resident owner’s share of PTE taxes to those imposed by the taxing state.12 If every state adopted such a regime, cross-border investment would be taxed twice (both in the state where the income was earned and in the state of the owner’s residence); double taxation would be avoided only insofar as PTE owners limited their investments to PTEs that conducted all of their activities in the owner’s state of residence.13

Connecticut’s mandatory PTE tax legislation reflects the foregoing concerns. To avoid double taxation of PTE owners, the legislation provides that each person who is subject to personal income tax and is a “member” of an “affected business entity” (namely, a PTE) “shall be entitled to a credit against the tax imposed” on the PTE “in an amount equal to such person’s direct and indirect share of the tax due and paid under this section by any affected business entity of which such person is a member.”14 The legislation then goes on to provide that Connecticut taxpayers

shall also be entitled to a credit . . . for such person’s direct and indirect share of taxes paid to another state . . . on income of any affected business entity of which such person is a member, . . . provided the taxes paid to another state . . . results from a tax that the commissioner determines is substantially similar to the tax imposed under this section.15

Other states have similar provisions. Maryland allows a credit to a resident PTE owner based on the owner’s pro rata share of the tax that a PTE pays to another state.16 New Jersey allows resident taxpayers to claim a credit for another state’s tax that “the director determines is substantially similar” to New Jersey’s PTE tax “with respect to the direct and indirect distributive proceeds from a pass-through entity” that are subject to tax in New Jersey.17 Rhode Island allows residents to claim a state tax credit in the “amount of tax paid by the pass-through entity . . . which is passed through to the owners, on a pro rata basis,” which includes “a similar type of tax imposed by another state on the owners’ income paid at the entity level.”18 Although the Wisconsin PTE legislation does not appear to address the creditability of other states’ taxes, its administrative guidance provides that if a PTE pays taxes to other states, the Wisconsin resident shareholders may claim a credit for the pro rata share of the PTE taxes paid under defined circumstances.19

Louisiana’s legislation differs from the general pattern of SALT cap workaround legislation by providing PTEs with an election to be taxed “as if the entity had been required to file an income tax return . . . as a C corporation.”20 To address the double taxation problem potentially raised by its legislation, Louisiana provides that “in computing Louisiana tax table income, an individual shall exclude net income or losses received from an entity of which the individual is a shareholder, partner, or member provided that the entity properly filed a Louisiana corporation income tax return.”21 However, the Louisiana legislation does not appear to address the question of the availability of an owner-level exclusion for other states’ taxes. Nor does the Oklahoma legislation, although the declared purpose of the Pass-Through Entity Tax Equity Act of 2019 — “to establish a revenue-neutral mechanism to provide a more fair and simplified taxation of pass-through entities and their members in this state”22 — would certainly support the case for a credit to avoid imposition of a double tax on the PTE income that would hardly be “revenue neutral.”

Whether or not a state explicitly provides for a credit against other states’ PTE taxes, and whether the taxes are mandatory or elective, as long as a state protects its residents from double taxation of their PTE income by providing a credit or exemption against the owner-level tax, it must likewise provide a credit against “such person’s direct and indirect share of taxes paid to another state . . . on income of any affected business entity of which such person is a member . . . from a tax that . . . is substantially similar to the tax”23 imposed by the state. The failure to do so clearly violates the internal consistency doctrine for reasons set forth above,24 and the elective nature of the tax does not provide an escape hatch from the constitutional command.25

III. Tax Credit Issues in States Without SALT Cap Workaround Legislation

The more controversial question is whether those states that have not adopted SALT cap workaround legislation will nevertheless provide their residents credits against other states’ SALT cap workaround taxes. This is essentially the same question that courts and administrative tribunals have confronted for many years regarding the creditability of other states’ entity-level taxes on PTEs borne by resident PTE owners, albeit, with the exception of the Massachusetts directive discussed below,26 not in the context of SALT cap workaround legislation.27 If what’s past is prologue,28 the issue is unlikely to elicit a uniform response from state tax authorities and adjudicative bodies.

Analytically, there are two different questions associated with the creditability of entity-level taxes for state personal income tax purposes. The first is whether the entity-level tax paid by the PTE is a tax on income within the meaning of the credit statute. If it is not, then the taxpayer should not be entitled to the credit regardless of the flow-through nature of the taxpayer’s interest.29 In this connection, it is important to emphasize that the critical inquiry, at least as a matter of tax policy, should be whether the tax is imposed on or measured by net income, not the label attached to the tax. If the tax imposed on the PTE is in substance an income tax, even if labeled a “franchise” tax or a tax on “doing business,” the credit should be granted to the PTE owner, regardless of the label attached to the exaction.

For example, the New York Tax Appeals Tribunal held that both the New Jersey and Connecticut corporate income taxes imposed on S corporations, though characterized as franchise taxes by courts in those states, were creditable income taxes within the meaning of New York’s credit provision.30 In so holding, the tribunal declared:

In characterizing the taxes for the limited purpose of the resident tax credit, we find that the label of the tax is not conclusive, but rather that the nature and practical effect of the tax is determinative. We adopt this approach, which requires examination of the substance and practical impact of the tax, because it furthers the legislative purpose behind the enactment of the resident tax credit, that is, to avoid double taxation on the same income.31

The tribunal therefore concluded that a New York resident S corporation shareholder was entitled to a credit for taxes that the S corporation paid to New Jersey and Connecticut.

The Utah Supreme Court reached a conclusion like that reached by the New York tribunal on similar grounds. The case involved Utah resident shareholders of S corporations that were subject to California and Texas franchise taxes at the entity level.32 The shareholders were individually responsible for the taxes imposed on the S corporations, and they claimed a credit against the tax on their Utah personal income tax returns. The Utah State Tax Commission denied the credit on the ground that the California and Texas taxes were imposed on the S corporations’ privilege of doing business in the state rather than on their “income,” as required by the Utah credit statute.33 Significantly, the commission had allowed credits paid by some of the S corporations to Georgia, Louisiana, and the District of Columbia, based on the wording of those jurisdictions’ taxes, as levies on income.

In a thoughtful opinion, the Utah Supreme Court ruled that the taxpayers were entitled to the credit. After paying appropriate lip service to the shibboleth that “tax credit statutes are to be strictly construed against the taxpayer,”34 the court found that the “plain language of [the statute] is clear in extending credits not only for taxes labeled as income taxes, but also for franchise or excise taxes measured by income.”35 The court found additional support for its conclusion in the fact that the legislature granted a credit for a tax “on income” rather than for an “income tax.”36 The court also observed that its reading of the statute was “wholly consistent with the statute’s purpose of avoiding double taxation.”37

Despite the persuasive reasoning of the opinions discussed above, it is important to keep in mind that courts and administrative tribunals have occasionally sustained the denial of credits to resident owners of PTEs on their share of the entity’s privilege or franchise taxes paid to other states, even though those taxes were measured by income, on the ground that a privilege or franchise tax fell outside the scope of the language of the statute authorizing the credit.38

A. Characterization of the Tax

Although the tax characterization issue has spawned controversy in the past,39 it should not create controversy regarding states’ SALT cap workaround legislation — at least based on the legislation that has been enacted to date. The SALT cap workaround taxes imposed on the PTEs are indisputably taxes imposed on income because they are measured by essentially the same income reflected in the resident taxpayers’ personal income tax returns.40 Nor can they credibly be characterized as privilege or franchise taxes imposed on the “privilege of doing business in the state,” as distinguished from taxes on income, and therefore ineligible for the credit granted for other states’ taxes on income as some courts have held in earlier litigation.41 Accordingly, denial of a credit for other states’ SALT cap workaround taxes on PTEs on the ground that the levies are not creditable income taxes appears highly unlikely.

B. Characterization of the Taxpayer

The more contentious question that is likely to arise in tax controversies over the creditability of other states’ entity-level PTE SALT cap workaround legislation is the characterization of the taxpayer. The ground for denial would be that the PTE, rather than the individual PTE member, actually paid the tax. We briefly summarize the relevant case law and administrative guidance below, reminding readers that the Massachusetts directive is the only guidance addressed specifically to other states’ entity-level PTE SALT cap workaround taxes.

1. Massachusetts

The Massachusetts Department of Revenue issued a directive concluding that Connecticut’s PTE tax42 is eligible for a credit against Massachusetts resident PTE members’ personal income tax, if they add back their pro rata share of the PTE tax paid by the entity when determining their distributive share of income subject to tax in Massachusetts.43 In reaching its conclusion, the directive relied on an earlier ruling in which the department had permitted resident partners in a Massachusetts limited partnership to take a credit against their distributive share of New Hampshire’s business profits tax that the partnership paid at the entity level.44 The Massachusetts partnership had invested in a New Hampshire partnership that invested in New Hampshire real property and proposed to sell the property at a substantial gain. New Hampshire imposes its tax on the net business profits of partnerships at the entity level. In describing its earlier ruling, the department observed:

The Department concluded that both the income and the tax payment were passed from the New Hampshire partnership through the Massachusetts partnership to the Massachusetts partners. It followed that the partners could apply their distributive shares of the New Hampshire Business Profits Tax payment as credits against their Massachusetts income tax.45

One must view the Massachusetts directive with caution, however, when evaluating how other states that have not adopted SALT cap workaround legislation will characterize other states’ PTE taxes, considering their contrasting treatment of New Hampshire’s business profits tax for purposes of their personal income tax credits for taxes paid to other states.

2. Maine

In contrast to the position embraced by Massachusetts, Maine has refused to grant a credit for its residents’ distributive shares of entity-level taxes imposed under New Hampshire’s tax. Maine provides a “resident individual” a credit against the state’s personal income tax “for the amount of income tax imposed on that individual . . . by another state.”46 A Maine resident, who was a member of a limited liability company that was classified as a partnership for federal income tax purposes, sought a credit for her proportionate share of New Hampshire’s business profits taxes that were imposed on the LLC. In sustaining the Maine taxing authority’s denial of the credit, the Maine Supreme Court concluded that “the plain meaning of an ‘income tax imposed on [an] individual’ excludes taxes that are imposed on, and paid by, business entities.”47 The court distinguished cases from other jurisdictions in which credits were permitted for other states’ taxes “imposed on individuals for unincorporated businesses,”48 and cases permitting credits for other states’ entity-level taxes imposed on flow-through entities but borne by individual resident flow-through entity owners. In support of its conclusion, the court emphasized that

the term “income tax” in Maine’s statute is a term of art; the statute does not use broad terminology to provide a credit for all taxes “on income” imposed by other states, including taxes on other states’ business entities’ income, but instead provides a credit only for income taxes paid by individuals on income derived from other states.49

The Maine court rejected an internal consistency attack against the denial of the credit. The court first observed that “the Maine statute expressly allows a credit for the payment of individual income taxes to other states, and therefore does not run afoul of Wynne.”50 It further noted that “neither the Supreme Court nor we have held that an individual must receive credit for taxes imposed on a business entity formed in another state by the taxing authority of that state.”51 Finally, and dispositively for purposes of internal consistency analysis, the court pointed out that Maine, unlike New Hampshire, imposed no tax on PTEs. Accordingly, Maine’s taxing regime passed the internal consistency test with flying colors: “Applying the internal consistency test, if all states had Maine’s tax statutes — including its statutes regarding the taxation of pass-through entities — there would be no disproportionate taxation of out-of-state income.”52 The difficulty for the taxpayers, as the court pointed out in conclusion:

arises from New Hampshire’s unusual scheme of taxing a pass-through entity on its profits and enterprise value, making New Hampshire LLCs different entities for tax purposes than the LLCs of Maine. Although New Hampshire’s taxation scheme may create a disincentive to form such entities in New Hampshire, it is not the application of Maine’s tax laws that creates that result.53

3. Louisiana

In Louisiana, a state that later adopted SALT cap workaround legislation,54 the courts sustained an internal consistency attack against the taxing authority’s denial to resident PTE owners of a credit against the state’s personal income tax for their share of an entity-based tax imposed by another state.55 Two Louisiana residents owned shares of LLCs and S corporations that paid entity-level franchise taxes to Texas, a state without a personal income tax, on the PTEs’ Texas-source income. The Louisiana residents paid their proportionate share of the PTEs’ tax and sought a credit against the Louisiana-residence based tax on their share of the PTEs’ income that Louisiana taxed on a flow-through basis. After a detailed review of the U.S. Supreme Court’s opinion in Wynne,56 the Louisiana court concluded that the Louisiana scheme suffered from the same constitutional flaw the Court had identified in that case:

Like the effect of Maryland’s tax scheme, [the Louisiana statute’s] failure to provide a credit results in the double taxation of income that is earned outside Louisiana, i.e., interstate commerce, but not intrastate income. Because the income, if earned in Louisiana, would only be taxed once, [the Louisiana statute] “creates an incentive for taxpayers to opt for intrastate rather than interstate economic activity” which, pursuant to Wynne, is violative of the dormant Commerce Clause. Louisiana residents who earn interstate income are forced into double taxation on all or a portion of their interstate income, whereas Louisiana residents with only intrastate income are not.57

As for the alleged inconsistency with the Maine case,58 which had denied a credit under similar circumstances because the other state’s tax was an entity-level tax, the court found differences in Maine’s and Louisiana’s statutory crediting provisions dispositive. Thus, in observing that it was “not persuaded” by the Maine court’s determination that “Maine’s credit for income tax paid in another state did not include business taxes paid in the other state,”59 the court invoked Louisiana precedent involving the creditability of a Texas franchise tax imposed on an S corporation and paid by Louisiana shareholders:

The Department contends that the credit cannot be given to the [Louisiana shareholders] for a tax liability owed and paid by the Corporation. There is no statutory requirement that the tax be imposed on the individual shareholders of an “S” Corporation or that the shareholders have personal liability for the tax in order for the credit to be allowed. [The Louisiana statute] does not require that the tax paid to the other state be imposed on or paid by the individual taxpayer. As long as a net income tax of another state is “paid” to that other state on income also taxable by Louisiana, a credit is allowed. Therefore, the fact that the Corporation paid the Texas tax does not prevent the tax from being available to an individual taxpayer for a credit pursuant to [the Louisiana statute].60

The court found additional support for distinguishing the Maine case in Maine’s tax laws, writing that “‘the term “income tax” in Maine’s statute is a term of art’ that provides ‘a credit only for income taxes paid by individuals on income derived from other states[,]’ and it did not apply to taxes imposed on business entities. Thus, the Maine case is readily distinguishable.”61

4. Arizona

The Arizona Court of Appeals held that the shareholder of a corporation that elected to be treated as an S corporation in Arizona (and for federal income tax purposes) but as a C corporation in Hawaii was not entitled to a credit against the shareholder’s portion of the corporate income tax that the corporation paid to Hawaii.62 During the tax years at issue, the taxpayers added their pro rata shares of the corporation’s Hawaii income taxes back into Arizona gross income in calculating their Arizona taxable income, and they sought dollar-for-dollar credits against the resulting Arizona income tax liabilities for their pro rata shares of the corporation’s Hawaii corporate income taxes.

The language of the Arizona statute did not explicitly address the question of whether an individual taxpayer is entitled to a credit for taxes paid by a C corporation to another state when that corporation has elected S corporation status in Arizona. The taxpayers claimed that the identity of the person or entity that paid the other jurisdiction’s tax was irrelevant as a matter of principle and that “all that matters . . . is that the tax was one on net income that was also ultimately subject to taxation in Arizona.”63 The department of revenue contended that the statute required that the taxpayer claiming a credit for taxes paid to another state must be the taxpayer responsible for paying those taxes. The department’s position was supported by its regulation that provided a credit for individuals whose income was included in a composite S corporation return, if all the requirements of the statute were met “and the taxes paid to the other state are imposed upon and paid directly by the individual taxpayer and not by the entity.64 The court concluded that the department’s position was “reasonable” 65 and that the history of the credit provision “indicates that the legislature did not intend to provide a credit in taxpayers’ situation.”66

Finally, the court addressed the taxpayers’ contention, based on an earlier case, that “the public policy of Arizona prohibits taxation of the same income by more than one state and that [the department of revenue’s] disallowance of these credits results in such double taxation.”67 The court distinguished the earlier case on the ground that it “involved taxation by two states on the same income of the same taxpayer.”68 By contrast, in this case, because the entity “elected to file in Hawaii as a C corporation, an independent legal entity, not as . . . a pass-through entity, the taxes at issue were paid by two separate tax-paying entities — taxpayers and [the Hawaii C corporation] — and not by the same legal entity.”69

It may be worth observing that the Arizona court’s observations would appear to be particularly relevant to the creditability of Louisiana’s PTE SALT cap workaround legislation, which provides PTEs with an election to be taxed “as if the entity had been required to file an income tax return . . . as a C corporation.”70

5. Ohio

The Ohio Department of Taxation has taken the position that resident owners of PTEs taxable at the entity level in Kentucky (Kentucky-taxable PTEs) are not entitled to a personal income tax credit against the Kentucky tax even if the Ohio resident elects to pay the Kentucky corporation income tax on the behalf of the Kentucky-taxable PTE.71 Because the Kentucky corporation income tax is imposed on the PTE and not directly on the equity investors of the PTE, the resident credit, which is limited to the “income . . . of a resident taxpayer that in another state . . . is subjected to an income tax,”72 is unavailable. As the department succinctly concluded, “with respect to the Kentucky corporation income tax, it is the pass-through entity — and not the equity investor — which is subject to the tax.”73

IV. Conclusion

The IRS’s notice recognizing the deductibility of the state PTE taxes at the entity level for federal personal income tax purposes has already spawned considerable interest regarding the issues raised by those levies for state tax purposes.74 Among these issues are the ability of PTE owners to claim a credit against their personal income tax liability in their state of residence for their distributive share of entity-level taxes paid to other states where the income was earned. We hope that the preceding discussion will facilitate the resolution of these issues in light of the underlying constitutional and policy concerns that we have identified.


1 Tax Cuts and Jobs Act of 2017, P.L. 115-97, 131 Stat. 2054 (Dec. 22, 2017).

3 The taxes were generally elective.

4 See Conn. Gen. Stat. Ann. sections 12-699, 12-699a; La. Rev. Stat. sections 47:287.732.1, 47:287.732.2, 47:297.14, 47:1675; Md. Code Tax-Gen. sections 10-102.1, 10-701.1; N.J. Stat. Ann. sections 54A:12-1 et seq.; Okla. Stat. Ann. tit. 68, sections 2355.1P-2, et seq., 2358(A)(11); R.I. Gen. Laws section 44-11-2.3; and Wis. Stat. sections 71.21(6), 71.365(4m).

5 See the legislation cited in the preceding note. These provisions generally are applicable to both resident and nonresident taxpayers, although the precise form in which the protection against taxation at both the entity and ownership level is provided may differ for resident and nonresident taxpayers.

6 IRS Notice 2020-75, 2020-49 IRB 1453 (Nov. 9, 2020).

7 Id. at section 1.

8 Id. at section 2.02(3).

9 Id.

10 Id. at section 3.02(1).

11 See infra Part III. See also Amy Hamilton, “Danger Ahead? IRS Greenlights Passthrough Workaround to SALT Cap,” Tax Notes State, Nov. 16, 2020, p. 745; Timothy P. Noonan and Joseph R. Rekrut, “IRS Blesses SALT Cap Workaround: What’s Next in 2021?Tax Notes State, Dec. 21, 2020, p. 1323; Steven N.J. Wlodychak, “IRS Just Raised State Taxes for Multistate Passthrough Entity Owners,” Tax Notes State, Dec. 14, 2020, p. 1159; cf. Brian Powers, “Insurance Company Tax Impacts of Passthrough Entity SALT Cap Workarounds,” Tax Notes State, Dec. 14, 2020, p. 1173.

12 The fact pattern is analogous to the facts of Comptroller of the Treasury v. Wynne, 575 U.S. 542 (2015), in which the Court invalidated a Maryland tax on internal consistency grounds for failure to provide a credit against another state’s tax on residents’ passthrough income from an S corporation, although the case did not involve an entity-level tax. The Wynne case is discussed in detail in Walter Hellerstein, “Deciphering the Supreme Court’s Opinion in Wynne,” 123(1) J. Tax’n 4 (2015). See generally Jerome R. Hellerstein, Walter Hellerstein, and John A. Swain, State Taxation para. 4.16[1] (2020) (providing detailed analysis of the U.S. Supreme Court’s commerce clause doctrine prohibiting “internally inconsistent” taxes).

13 The issue would not arise regarding nonresident PTE owners because they would be taxable only on a source basis, and the states’ PTE SALT cap workaround legislation has already addressed the problem of double taxation on a source basis at both the entity and ownership level for nonresidents and residents.

14 Conn. Gen. Stat. Ann. section 12-699(g)(1)(A).

15 Id. section 12-699(g)(1)(B).

16 Md. Code, Tax-Gen. section 10-703(d)(2).

17 N.J. Stat. Ann. section 54A:4-1(f).

18 R.I. Gen. Laws section 44-11-2.3.

19 Wisconsin Department of Revenue, “Wisconsin Tax Treatment of Tax-Option (S) Corporations and Their Shareholders,” Pub. 102 (02/20).

20 La. Rev. Stat. section 47:287.732.2(A)(1). In this connection, it is worth observing that state nonconformity to federal entity classification — even if limited and selective — may open a Pandora’s box for tax planning opportunities.

21 Id.

22 Okla. Stat. Ann. tit. 68, section 2355.1P-3.

23 Conn. Gen. Stat. Ann. section 12-699(g)(1)(B).

24 See text accompanying notes 12-13 supra.

25 Under the doctrine of “unconstitutional conditions,” the government may not offer a benefit that is subject to the condition that the recipients waive their constitutional rights. Whether one embraces the strict version of the doctrine, under which the government may never condition a benefit on the waiver of a constitutional right, or the more relaxed version, under which the government may only condition the waiver “when ‘the state presents compelling interests’ for doing so,” Edward J. Fuhr, “The Doctrine of Unconstitutional Conditions and the First Amendment,” 39 Case W. L. Rev. 97, 100 (1989) (citation omitted), a state’s conditioning of a taxpayer’s right to relief from the federal SALT deduction on the waiver of its residents’ protection from discrimination against interstate commerce would appear to be unconstitutional. A state would be hard pressed to defend the proposition that it has a compelling state interest in denying residents a tax credit against other states’ tax regimes that are substantially the same as its own. Cf. Kraft General Foods Inc. v. Iowa Department of Revenue, 505 U.S. 71, 78 (1992) (“We find no authority for the proposition . . . that a tax that does discriminate against foreign commerce may be upheld if the taxpayer could avoid that the discrimination by changing the domicile of the corporations through which it conducts its business.”).

26 See infra Part III.B.1.

27 See Hellerstein, State Taxation, supra note 12, paras. 20.10[2], 20.10[3], from which the ensuing discussion freely draws.

28 As one of the coauthors (without any claim to originality(!), see William Shakespeare, The Tempest, Act II, Scene 1) has recently suggested on these pages, Walter Hellerstein, “What’s Past Is Prologue,” in Jéanne Rauch-Zender, “Forging Ahead in 2021,” Tax Notes State, Dec. 21, 2020, p. 1259.

29 For example, in Keller v. Department of Revenue, 872 P.2d 414 (Or. 1994), the Oregon Supreme Court denied Oregon residents a credit for payments made under Washington’s Business and Occupation (B&O) Tax, an excise tax on the privilege of doing business in the state measured by the business’s gross income, gross proceeds, or gross value of products. In the court’s view, “the Washington B&O tax taxes business activities, and not income.” Id. at 415. Accord Idaho State Tax Commission, Ruling No. 1-881-960-448 (Dec. 8, 2017) (“Since Washington’s Business and Occupation excise tax does not permit a taxpayer to offset its income by deductions for cost of goods or services rendered, it cannot be considered an ‘income tax imposed by another state.’”); Missouri Department of Revenue, Private Letter Ruling LR 7030 (Feb. 3, 2012) (“The B&O tax is not ‘based on’ federal taxable income, which is income net of various credits and deductions. The B&O tax is based on the gross income or gross receipts of businesses which operate in Washington.”); see also Virginia Department of Taxation, Ruling of the Tax Commissioner, Pub. Doc. No. 88-38 (Mar. 8, 1988) (denying a resident S Corporation shareholder a personal income tax credit for the resident’s distributive share of West Virginia’s former Business and Occupation Tax paid by the S Corporation).

30 In re Baker, TSB-D-90(28)I, 1990 WL 169491 (N.Y. Tax App. Trib. Oct. 11, 1990).

31 Id. at *5 (citations omitted).

32 MacFarlane v. Utah State Tax Commission, 134 P.3d 1116 (Utah 2006). Texas, a state without a personal income tax, does not recognize S corporations as PTEs. While California recognizes S corporations for state tax purposes, it permits foreign S corporations doing business in the state to elect to be treated as C corporations. Although the S corporations in question had elected to be treated as C corporations in California and the taxes were imposed on the corporations, the shareholders were responsible for the payment. Hence, as a practical matter, there was no difference between the shareholders’ position vis-à-vis the entity-level taxes imposed by California and Texas.

33 Utah Code Ann. section 59-10-1003 provides that a resident may claim a “tax credit against the tax otherwise due . . . equal to the amount of the tax imposed . . . by another state . . . on income . . . derived from sources within that other state . . . if that income is also subject to tax under this chapter.”

34 MacFarlane, 134 P.3d at 1118.

35 Id. (emphasis supplied). In this respect, the court was taking the same approach to the credit issue that the U.S. Supreme Court had taken to state taxation of interstate commerce when it rejected the formal distinction between a permissible direct tax on net income from interstate commerce and an impermissible tax on the privilege of engaging in interstate commerce measured by net income and, in so doing, repudiated a jurisprudence based on “magic words or labels.” See Hellerstein, State Taxation, supra note 12, para. 4.10[2]. The Utah court explicitly recognized this analogy. MacFarlane, 134 P.3d at 1119-1120.

36 MacFarlane, 134 P.3d at 1119-1120 (citing and quoting Roach v. Comptroller of the Treasury, 610 A.2d 754, 759 (Md. 1992)).

37 Id. at 1118.

38 See Hellerstein, State Taxation, supra note 12, para. 20.10[3].

39 See id. (discussing the case law addressing this issue in detail).

40 See supra note 5.

41 See text accompanying note 38 supra; and Hellerstein, State Taxation, supra note 12, para. 20.10[3].

42 The tax is discussed in text accompanying notes 14-15 supra.

43 Massachusetts Department of Revenue, “Directive No. 19-1: Application of the Massachusetts Personal Income Tax Credit for Taxes Paid to Another Jurisdiction to the Connecticut Pass-Through Entity Tax” (Sept. 19, 2019).

44 Massachusetts Department of Revenue, Letter Ruling. 87-10 (Oct. 10, 1987).

45 Id.

46 Me. Rev. Stat. tit. 36, section 5217-A.

47 Goggin v. State Tax Assessor, 191 A.3d 341, 345 (Me. 2018).

48 Id. (emphasis in original).

49 Id. at 346 (emphasis in original).

50 Id. at 347 (citation omitted). The reference is to Comptroller of the Treasury v. Wynne, 575 U.S. 542 (2015), discussed in note 12 supra.

51 Goggin, 191 A.3d at 347 (emphasis in original).

52 Id. at 348.

53 Id. (emphasis in original).

54 See text accompanying notes 20-21 supra.

55 Smith v. Robinson, 265 So. 3d 740 (La. 2018) (affirming the decision of the 9th Judicial District Court, East Baton Rouge Parish).

56 See supra note 12.

57 Smith, 265 So. 3d at 754 (citation omitted).

58 See supra Part III.B.3.

59 Smith, 265 So. 3d at 748 n.9 (citation omitted).

60 Id. at 747 (quoting Perez v. Secretary of Louisiana Department of Revenue and Taxation, 731 So. 2d 406, 409 (La. App. 1999), writ denied, 743 So. 2d 1256 (La. 1999) (citation omitted)).

61 Id. at 748 n.9 (La. 2018) (quoting Goggin, 191 A.3d 341, 346 (emphasis in original Maine opinion, citation omitted)).

62 Davis v. Arizona Department of Revenue, 4 P.3d 1070 (Ariz. App. 2000).

63 Id. at 1072.

64 Id. at 1073 (quoting the regulation, emphasis supplied by the court). The current regulation, although amended in some respects, is in substance the same as the regulation under consideration in Davis. See Ariz. Admin. Code R15-2C-1071.

65 Id.

66 Id.

67 Id. at 1074.

68 Id. (emphasis in original).

69 Id. (emphasis in original).

70 La. Rev. Stat. section 47:287.732.2(A)(1). See text accompanying notes 20-22 supra.

71 Ohio Department of Taxation, Tax Information Release IT 2006-02 (Mar. 1, 2006).

72 Ohio Rev. Code section 5747.05(b).

73 Ohio Department of Taxation, supra note 71.

74 See supra note 11.


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