Using Pass-Through Entity Tax Benefits In M&A Transactions

Individual taxpayers who itemize deductions on their federal income tax returns generally can offset federal taxable income for taxes paid to state and local governments. However, the Tax Cuts and Jobs Act of 2017 created a $10,000 limitation on an individual taxpayer's ability to deduct those taxes. This limitation commonly referred to as the "SALT cap" can be costly, particularly to sellers in M&A transactions.

In response to the SALT cap, many states enacted pass-through entity tax ("PTET") regimes for partnerships or S corporations. In a PTET regime, taxpayers may elect to have flow-through entities pay income tax at the entity level. The entity-level income tax is not subject to the SALT cap that applies only to individuals. This results in income allocated to the pass-through entity's owners that reflects "deductions" for the full amount of state and local taxes the entity paid. Additionally, owners typically receive a credit against their individual state