Massachusetts DOR Report Endorses SALT Cap Workaround

Client Alert
March 10, 2021

A new Massachusetts Department of Revenue (DOR) Report to the Legislature supports changing the Commonwealth’s tax law to enable owners of partnerships and S corporations to avoid the federal limitation on state and local tax deductions.[1] The Report concludes that a passthrough entity (PTE) tax "workaround"—essentially, an entity‑level tax on passthrough businesses, coupled with a refundable credit for each member’s distributive share of such tax—would be largely revenue neutral, would provide meaningful tax benefits to a large number of Massachusetts businesses, and would help maintain Massachusetts’ competitiveness with other states that have already enacted similar workarounds.

There is a fifth‑dimensional quality to reading a DOR Report that endorses a $1.12 billion tax avoidance measure. (Where are you, Rod Serling?) The deep explanation for this DOR venture into tax planning lies partly with Congress, partly with Treasury, and partly with whose tax is being avoided. Congress and the Biden administration have been noncommittal about repealing the federal deduction limitation for state and local taxes. Meanwhile the Treasury Department and the IRS have blessed state tax workarounds that enable PTE owners to avoid the $10,000 federal limitation on the state and local tax (SALT) deduction for their passthrough income.[2] These circumstances leave it to the Legislature to decide whether to take advantage of the opportunity to arrange the Commonwealth’s tax laws so that passthrough owners’ federal income taxes may be as low as possible. The DOR Report assists by providing valuable context, analysis, and recommendations that we summarize here.


An outside section of the Commonwealth’s FY21 budget directed the DOR to evaluate the revenue and administrative impact of implementing an entity-level tax on noncorporate businesses, coupled with a refundable credit for each member, as a "credit model" workaround to the federal SALT cap.[3] As explained in the Report, such a workaround avoids the federal SALT cap imposed on individuals by shifting the state tax burden from the PTE owners to the PTEs themselves:

A PTE tax imposed at the entity level potentially allows PTE owners a federal tax benefit equivalent to the amount of federal tax incurred as a result of the disallowance of SALT expenses in excess of $10,000. Under the contemplated entity-level PTE tax and accompanying credit, individual partners and shareholders would receive this federal tax benefit without increasing their Massachusetts tax.[4]

Workarounds in Other States

The Report surveys credit model workarounds such as those enacted in Connecticut, Maryland, New Jersey, and Rhode Island, while also describing "deduction model" workarounds enacted in Alabama, Louisiana, Oklahoma, and Wisconsin. The Report highlights differences among these regimes. Two of these regimes have been in effect since 2018, four since 2019, one since 2020, and one since earlier this year. The Report notes that proposals are also pending in New York, Michigan, Minnesota, and Arkansas. The Report does not mention the workaround proposals pending in California or Arizona.[5]

Revenue Impact

The Report estimates that approximately 55,500 Massachusetts personal income tax filers would benefit from a Massachusetts PTE tax workaround. These filers reported on average $59,505 of state income tax in 2019. The Report estimates that they could save on average $20,158 of federal tax annually, if their state income tax were wholly attributable to flow-through income. The Report concludes:

In total, the 55,500 filers … reported SALT taxes that exceeded their aggregate federal cap by $3.2 billion. If this entire $3.2 billion were deducted on federal returns as the result of an enacted potential PTE tax, it would reduce the federal tax burden for these filers by $1.12 billion.

While the workaround would be expensive for the federal government, the Report "estimates that a PTE tax and corresponding refundable credit would be revenue neutral for Massachusetts, or slightly revenue positive" simply because some taxpayers fail to claim credits for which they are eligible.[6]

Administrative Impact

Implementing a PTE tax workaround would pose a number of administrative challenges, but the Legislature could lessen these challenges by drafting with an eye toward administrative efficiency. "To administer a revenue neutral PTE tax the DOR would have to develop a reporting, accounting, and enforcement system that as nearly as possible collects the same amount of tax as would have been paid by the PTE owners."[7] Implementing such a tax would be "resource-intensive" because the new regime would require reprograming existing systems and additional audit resources, but none of the implementation challenges would be “insurmountable."[8] After all, the "DOR navigates similar issues in administering existing taxes."[9]

The Report notes two ways for the Legislature to improve the administrative efficiency of any workaround. First, an elective regime would be less complex than a mandatory regime and would provide flexibility if the federal SALT cap is repealed. Second, allowing election into the regime at the entity level would be simpler for tax administration purposes than allowing election at the owner level.

The Report notes that the Legislature must also decide whether to include or exclude corporate owners of PTEs from any workaround. C corporations, the Report acknowledges, are not subject to the federal SALT limitation and would not benefit from inclusion.

The Report also notes a dozen additional issues for the Legislature’s consideration.  Among these, the Report recommends that any legislation enacting a PTE tax workaround:

Proposed Legislation

The Report notes that the Baker-Polito Administration’s FY 2022 budget proposes a PTE tax workaround.[11] Under a new Chapter 64F, Taxation of Pass-Through Entities, for taxable years beginning on or after January 1, 2021, an eligible PTE could elect to pay an excise on its qualified income taxable in Massachusetts at a rate of five per cent, and a qualified member of an electing PTE would be allowed a credit against the personal income tax imposed on such member’s share of such excise paid by the PTE. Qualified income taxable in Massachusetts would include the income of an eligible PTE determined under the personal income tax, allocable to qualified members, and included in such members' Massachusetts personal income tax. Qualified members would include S corporation shareholders and partners that are natural persons.

Election into the regime would be made by the eligible PTE on an annual basis, would bind all members of the electing PTE, and would be irrevocable once made. Regulations would, "to the extent feasible," ensure that an electing PTE and its qualified members pay an aggregate amount of tax that is generally equivalent to the amount of tax that would have been due from members under the personal income tax in the absence of an election to pay an entity-level excise. Regulations would also address tiered structures, trusts, and estimated tax payments.

The proposed workaround regime would not apply to taxable years when the federal SALT cap has expired or is otherwise not in effect.


What should the Massachusetts Legislature do while the federal cap on SALT deductions remains in place? The DOR’s conclusion is clear:

If Massachusetts were to enact legislation to allow a PTE tax and corresponding credit, it would provide meaningful tax benefits to partnerships and S corporations, which make up a large number of businesses in Massachusetts, and to their owners. Further, it would help to maintain the Commonwealth’s competitiveness with other states that have adopted similar provisions. By making the tax and credit equal, such legislation would be revenue neutral, while creating federal tax savings for owners of Massachusetts PTEs. The DOR would have to expend resources to implement the PTE tax and corresponding credit, but implementation of the PTE tax and credit would be feasible. Legislation that follows the model described above would simplify implementation and administration of the tax. As mentioned above, such a proposal was included in the Governor’s Fiscal Year 2022 Budget Recommendations.[12]

There are certainly reasons why states or PTEs might be wary of advocating a PTE tax workaround.[13] Implementing a new regime could become unnecessary if Congress repeals or modifies the SALT cap before its scheduled expiration after 2025. From the PTE perspective, a nonresident owner could effectively be subject to double tax if their home state lacks a workaround regime and denies credit for the Massachusetts PTE tax because, for example, the tax is paid by the PTE rather than the owner. PTE owners may also worry about letting the camel’s nose under the tent, and the possibility of the Legislature eventually reducing the allowable credit to generate net revenue for the Commonwealth.

It remains uncertain whether Congress will repeal the SALT cap. In the meantime, a growing number of states have forged ahead with workarounds intended to benefit their residents at essentially no direct revenue cost to themselves. Now that the DOR has completed its Report, and the Governor has proposed legislation, all the Legislature has to decide is whether to follow the clear import of the DOR’s conclusions.

[1]  See Commonwealth of Massachusetts Department of Revenue, "Report on the Administrative and Revenue Impact of a Proposal to Allow Owners of Certain Entities to Avoid the Federal Limitation on State and Local Tax Deductions" (Mar. 1, 2021) (the Report).

[2]  See IRS Notice 2020-75, 2020-49 I.R.B. 1453 (Nov. 30, 2020) [link here].

[3]  See FY2021 Budget, Section 89 [link here]. See also Sullivan Insights, "Key Tax Provisions in the Massachusetts FY21 Budget" (Dec. 18, 2020) [link here].

[4]  Report, pg. 2.

[5]  California S.B. 104 [link here]; California Governor’s Budget Summary 2021-22 (Jan. 8, 2021), pp. 31, 246-47 [link here]; Arizona S.B. 1783 [link here]; Arizona H.B. 2838 [link here].

[6]  Report, pg. 5.

[7]  Id.

[8]  Report, pg. 6.

[9]  Id.

[10]  Report, pg. 7.

[11]  See FY22 Budget Recommendation, Section 28 (Pass-Through Excise) [link here].

[12]  Report, pg. 7.

[13]  See, e.g., Lynnley Browning, "Avoiding the SALT Cap Might Actually Spark a Larger Tax Bill," Financial Planning, Feb. 26, 2021 [link here]; Walter Hellerstein and Andrew Appleby, "State Tax Credit Issues Raised By SALT Cap Workaround Legislation," 99 Tax Notes State 211 (Jan. 18, 2021); Timothy P. Noonan and Joseph R. Rekrut, "IRS Blesses SALT Cap Workaround: What’s Next in 2021?," 98 Tax Notes State 1323 (Dec. 21, 2020); Steven N.J. Wlodychak, "IRS Just Raised State Taxes for Multistate Passthrough Entity Owners," 98 Tax Notes State 1159 (Dec. 14, 2020); Jared Walczak, "IRS Signals Approval of Entity-Level SALT Cap Workaround, But States Should Still Think Twice," Tax Foundation, Nov. 11, 2020 [link here].

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