New Guidance Clears Up Partnership Deduction for State, Local Taxes

A new notice from the Internal Revenue Service reveals some new rules that are expected to be included in upcoming proposed regulations.

Notice 2020-75 spells out the proposed regulations clarifying that state and local income taxes imposed on and paid by a partnership or S corporation on its income are allowed to be claimed as a deduction by the filing partnership or S corp.

The filing entity, the notice continues, would use the state and local taxes paid to calculate its non-separately stated taxable income or loss for the taxable year of payment. Therefore, the notice concludes, the tax payments are not subject to the limitation for state and local taxes on partners and shareholders who itemize deductions.

“This definition does not include income taxes imposed by U.S. territories or their political subdivisions,” the notice states. “Thus, this definition solely includes income taxes described in section 164(b)(2) for which a deduction by a partnership is not disallowed under section 703(a)(2)(B), and such income taxes for which a deduction by an S corporation is not disallowed under section 1363(b)(2).”

Further, the notice puts the changes in play immediately and details when the new rules can be applied to specified tax payments:

“The proposed regulations described in this notice will apply to Specified Income Tax Payments made on or after November 9, 2020.The proposed regulations will also permit taxpayers described in section 3.02 of this notice to apply the rules described in this notice to Specified Income Tax Payments made in a taxable year of the partnership or S corporation ending after December 31, 2017, and made before November 9, 2020, provided that the Specified Income Tax Payment is made to satisfy the liability for income tax imposed on the partnership or S corporation pursuant to a law enacted prior to November 9, 2020.”

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Source: IR-2020-252

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