State legislatures continue to seek creative solutions to the federal income tax deduction limit on state and local taxes known as the 'SALT cap.' Significant attention has been focused on the viability of individual state workarounds but, the other side of the SALT cap analysis, the interplay between each state’s unique workarounds has received less coverage.
This ‘other’ side of the SALT cap analysis is the subject of newly published Directive 19-1 issued by the Massachusetts Department of Revenue in response to Connecticut’s Pass-Through Entity Tax. The Directive provides guidance for Massachusetts resident taxpayers with Connecticut-source income earned by a pass-through entity such as a partnership or S-corporation. The Connecticut workaround functions similarly to the Rhode Island SALT workaround discussed in our most recent newsletter available at this link so this Directive may serve as a preview for future Department of Revenue guidance.
Effective for taxable years beginning after January 1, 2018, pass-through entities with Connecticut source income are required by Connecticut Public Act No. 18-49, § 1(a)(3), to file an income tax return and pay a “Pass-Through Entity Tax”. The new law then provides owners of the pass-through entity with a credit against their Connecticut personal income taxes for their allocable share of the pass-through entity’s Connecticut tax liability. One of the goals of the Connecticut legislation is to bypass the SALT cap by shifting a state-level personal income tax liability to a business-level income tax liability not limited by the SALT cap. The Directive provides guidance on the interplay between the Connecticut statute and the Massachusetts personal income tax law.
Massachusetts law generally provides for a credit against Massachusetts personal income taxes for income taxes paid to any other state, territory, possession of the United States, or any province of Canada (the “Credit”). The Credit presumes that taxes paid to the other jurisdiction are paid by the Massachusetts resident individually. By shifting a Connecticut personal income tax liability to the business level through Connecticut’s SALT workaround, the application of the Credit was uncertain. The Directive provides taxpayers with clarity and relief – preserving the legislative intent of the Credit for Massachusetts residents.
The Directive clarifies that an individual or other taxpayer subject to the Massachusetts personal income tax who is (i) a resident of Massachusetts and (ii) an owner of an entity subject to the Connecticut Pass-Through Entity Tax is eligible for the Credit for the taxpayer’s distributive share of income. The Credit is allowed only if the taxpayer adds back his or her pro rata share of Connecticut Pass-Through Entity Tax paid to the amount of the taxpayer’s distributive share of income from the entity subject to Massachusetts personal income tax. The amount of distributive share of income and the amount of Connecticut Pass-Through Entity Tax paid on behalf of the owner of a Connecticut pass-through entity is reported on either Massachusetts Schedule 3K-1 (by partnerships) or Schedule SK-1 (by S-corporations). The amount of Connecticut Pass-Through Entity Tax must be added back and included in the income reported by the Massachusetts resident on his or her Massachusetts personal income tax return.
One issue on which further guidance is needed is the expansion of the Directive to apply to similar SALT workarounds enacted by other states. The Directive, however, does provide relief to affected taxpayers while also illustrating the other side of the SALT cap issue. The Directive is a welcome step forward in establishing a complementary relationship between the personal income tax laws of each state to ensure that various SALT cap workarounds do not create unanticipated state income tax consequences.
The tax attorneys at McLaughlinQuinn LLC regularly represent clients in connection with tax planning for the complex interplay between federal and state income taxes. For more information on this newsletter, contact Cory J. Bilodeau, Esq., Tax Planning Partner, at (401) 655-2203 or via email at
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