Since Maryland passed Senate Bill 523 on May 8, 2020, providing a state and local tax (SALT) workaround, professionals in the accounting industry have been waiting for additional guidance on how this new bill would work.
When Maryland issued Administrative Release No. 6 on September 15, 2020 in an effort to provide guidance on paying tax at the entity level and to whom the tax would apply, many questions remained.
Surprisingly, the IRS released Notice 2020-75 on November 9, 2020, giving the approval for S-Corporations and LLCs to pay Maryland taxes at the pass-through entity level rather than on individual income tax returns. In other words, this workaround moves the deduction off of Schedule A Itemized Deductions (limited to $10,000) and moves them over Schedule E as an ordinary deduction (not limited to $10,000).
Points to consider:
- The tax is calculated based on distributive income found on Maryland Form K-1 at 8% for individuals & fiduciary members and 8.25% for entities
- The annual election will be made at the entity level and not at the member or shareholder level
- Schedule C tax filers will not be eligible
- Maryland decoupling modification adjustments are not taken into consideration in the calculation of the tax
- IRS is requiring both accrual and cash basis taxpayers to pay the tax on or before 12/31/2020
- The tax is calculated based on the entire year, not just Q4 when official guidance came out. This workaround is only available to those taxpayers with tax years starting 1/1/2020 or after.
- Maryland residents will get a credit for Maryland taxes paid on their behalf
- Maryland will not allow Q1, Q2, and Q3 payments made at the individual level to be moved over to the pass-through entity level
- The draft of Maryland Form 510 for 2020 is not yet available
Points that need further clarification:
- Will Maryland non-residents be able to participate at the entity level tax?
- If the pass-through entity files in multiple states, does the Maryland resident need to pay tax for all income in Maryland, along with payments to other states?
- Will Maryland abate underpayment penalties if the payment for the entire year is made in Q4?
Points to keep in mind for the future:
- It is possible that an individual taxpayer has already paid in ¾ of the year in estimated taxes. For 2020, the entity would be paying the entire 2020 tax liability with the Q4 voucher. While a timing difference, it is a lot of cash out in Q4.
- The one making the decision to pay the tax at the entity level should have something to the LLC members or shareholders explaining the decision. Consider adding language to the Operating Agreement or Shareholders Agreement that addresses this specific matter, and who is in charge of making the election.
- Remember that allocations are generally pro rata. Should there be changes in the S-corporation ownership during the course of the year, the above workaround may benefit some more than others.
- Individuals who receive a credit at 8.0% for taxes paid at the entity level may be under-withheld if taxed at a higher rate. For example, a high-income earner in Baltimore City would have a maximum rate of 8.95%.
As with most guidance from taxing authorities, questions remain unanswered.
Each situation is unique. As such, we strongly encourage you to talk to your accountant and financial advisor to decide what’s right for you.