In Notice 2020-75, the IRS announced that it will allow above-the-line deductions for state tax workarounds on pass-through entities. Following enactment of the $10,000 cap on state income tax deductions for individuals under the Tax Cuts and Jobs Act of 2017, some states enacted new tax structures for pass-through entities that impose state income tax directly on pass-through entities rather than on the individual owners. These pass-through entity tax structures typically are paired with a credit for the individual owner on pass-through income for the tax paid by the pass-through entity.
Under the notice, the IRS will treat state income taxes directly imposed on pass-through entities as a business expense of the pass-through entity. The expense is not subject to the $10,000 limit, even if the individual receives a credit for the tax paid by the pass-through entity on his or her personal return.