Issues and Limitations with the Maryland SALT Deduction Workaround

9 min

Effective July 1, 2020, a pass-through entity (PTE) with Maryland-source income can elect to be taxed at the PTE level (rather than the individual level) with respect to its individual Maryland resident owners on the PTE's Maryland taxable income for Maryland state and local income tax purposes. Maryland Tax-Gen. Section 10–102.1; Chapter 641 of the Laws of Maryland of 2020. The election is intended to circumvent the $10,000 limit on the federal deductibility of state and local taxes (the SALT deduction) imposed by the Tax Cuts and Jobs Act of 2017 (TCJA). That limitation has already had a significant impact on the federal income tax liability of individual taxpayers resident in high-state income tax states such as Maryland.

In response, many states passed legislation attempting to reverse the economic impact of the limitation of the SALT deduction on an individual's federal income tax liability. Most states took one of two approaches: (1) providing individual taxpayers with a state tax credit in exchange for making a purportedly deductible charitable contribution to a state or other specified nonprofit fund; or (2) imposing an entity-level tax on PTEs that previously were not otherwise subject to tax at the state income tax rate and providing the PTE's members with a state tax credit in the same amount. The first approach attempts to convert a SALT deduction into a charitable contribution deduction, while the second approach converts an individual's SALT deduction into a PTE-level deduction. In August, the IRS issued guidance that largely eliminated the first SALT deduction workaround. The IRS, however, has not issued any guidance regarding the PTE workaround adopted by Maryland and other states, indicating that a workaround like Maryland's may pass muster at the federal level.

The Venable tax team has issued prior guidance describing the application of Maryland's SALT deduction workaround, which can be found here. In addition, the Maryland Comptroller updated Administrative Release No. 6 in September 2020 to provide additional information regarding the workaround, including guidance on filing requirements.

This alert provides an in-depth example and discussion of how the workaround should be applied in the case of a PTE with Maryland resident and nonresident members and discusses special problems that may arise in the S corporation context. In the examples below, state tax rates are assumed to be the highest rates applicable to individuals and rounded to simplify the presentation.


MVC LLC (MVC) has offices in Maryland (9% tax rate), California (13% tax rate), and Virginia (6% tax rate). Mary operates the Maryland office, Vaughn operates the Virginia office, and Carl operates the California office. Each has a one-third interest in MVC's income and loss.

In 2020 MVC has $900 of taxable income from all sources, with $300 apportioned respectively to each of Maryland, Virginia, and California.

PTE Taxed as an LLC

No Workaround

Mary pays Maryland tax of $9, which is 9% of her one-third share ($100) of MVC's Maryland taxable income ($300) on her Maryland personal income tax return.

Vaughn has Maryland nonresident withholding tax of $9. This tax is paid on his behalf by MVC and treated as a distribution to him. The tax is creditable against his Virginia personal income tax only to the extent of $6 (6% Virginia tax rate applied against his $100 of Maryland-source income).

Carl has Maryland nonresident withholding tax of $9. This tax is paid on his behalf by MVC and treated as a distribution to him. Because of the higher California income tax rate, Vaughn gets the benefit of a credit for the full $9 in Maryland tax against his California personal income tax.

For Vaughn and Carl, the tax withheld by MVC is merely a means of collection of the Maryland income tax due by each. Therefore, the entity has no entity-level deduction of Maryalnd income tax for the amounts withheld for Vaughn and Carl. Likewise, there is no entity-level deduction with respect to the taxes paid by Mary. The Maryland income tax payments of the members, together with their payments of income tax to other states (California and Virginia), constitute itemized deductions for federal income tax purposes subject to the SALT deduction cap.

Accordingly, for federal income tax purposes, each member has $300 of income subject to tax. Assuming a 37% tax rate, this results in federal income tax due from each of Mary, Vaughn, and Carl of $111.

With Workaround

Alternatively, under the new Maryland law, MVC can elect to pay Maryland income tax at the entity level with respect to its Maryland resident member, Mary, resulting in the following consequences for Maryland income tax purposes:

  • MVC pays $9 in Maryland income tax with respect to Mary's share of MVC's taxable income. The tax is an entity-level tax. The entity has an entity-level deduction against taxable income for the tax paid to Maryland with respect to Mary's share of the entity's Maryland-source taxable income.
  • Assuming the special allocation discussed below is made, Mary is allowed to take a credit on her individual Maryland tax return for the $9 in Maryland tax paid by MVC. As a result, her Maryland tax burden is not affected by the entity-level tax.
  • MVC continues to pay $9 in Maryland income tax on behalf of Vaughn and Carl, which they can use in whole or in part as a credit against their resident state income tax burden. The current legislation does not allow this nonresident withholding tax to be treated as an entity-level tax, even though it is paid by the entity.

The only result of the Maryland SALT deduction legislation is the shifting of the burden of the $9 in Maryland income tax due with respect to Mary's share of MVC's Maryland-source income from Mary to MVC. As shown below, however, this shift could result in significant federal income tax savings. With respect to Maryland nonresidents Carl and Vaughn, the Maryland PTE withholding statute still refers to the tax collected and paid to MD as being "paid on behalf of" the nonresident members of the PTE. As a result, the $9 respectively paid on their behalf remains an individual tax of each nonresident member that has merely been withheld by the MVC to fund the nonresident members' ultimate Maryland individual tax liabilities for the year. In contrast, for Maryland resident Mary, the changes to Maryland law treat the tax electively paid with respect to her share of MVC's Maryland-source income as imposed on MVC and as to which she is allowed a credit against Maryland taxable income.

Thus, if MVC elects to pay the PTE-level tax under the new legislation, the tax paid by MVC with respect to Mary's share of MVC's income is an entity-level tax deductible by MVC in calculating its taxable income. Presumably, MVC would want to specifically allocate the deduction for the $9 iin Maryland entity-level income tax to Mary so that she alone both bears the economic burden of the Maryland tax and receives the federal tax benefit of the entire Maryland SALT deduction. Assuming such special allocation is made, Mary's share of pass-through income from MVC is reduced from $300 to $291 for federal income tax purposes, such that only she bears the economic cost of the deduction.

In addition, only Mary realizes the federal income tax benefit of the deduction, with none of such benefit being allocated to Carl or Vaughn. Therefore, although Vaughn and Carl still would have a $111 federal income tax burden, Mary's federal income tax burden would be reduced to $107.67 (i.e., 37% of $291, rather than 37% of $300).

If, in contrast to our MVC example, all members of a Maryland PTE are Maryland residents, no special allocation of the deduction would be needed. All members would share proportionately in the deduction, and everything would be "in sync."

It should be noted that a PTE with both Maryland and non-Maryland resident members would need to amend its existing operating agreement to specially allocate the SALT deduction to its Maryland resident members and thus avoid the economic and tax distortions referenced above. Absent such an amendment, there is nothing in the statute or the Comptroller's guidance that effects any type of special allocation of the PTE-level tax deduction.

In order to avoid Mary receiving the benefit of both a Maryland credit and deduction for the same $9 amount, we must expect that: (i) when the election is made by MVC on behalf of Mary, Maryland will require Mary to add the deduction back to Maryland-source income when computing her Maryland taxable income (so that for Maryland income tax purposes, Mary's share of pass-through income is $300 rather than $291); or (ii) MVC will be required to add back (not take) the deduction for the Maryland entity-level tax when reporting its Maryland-source taxable income to Mary, its sole Maryland resident owner, on MVC's Maryland Schedule K-1. But the certainty of these outcomes is dependent on further guidance being issued by the Maryland Comptroller on the implementation of Maryland's PTE SALT deduction.

PTE Taxed as an S Corporation

No Workaround

If MVC was instead taxed as an S corporation, MVC and its shareholders generally would have the same tax consequences as if MVC were taxed as an LLC.

With Workaround

If MVC were to be classified as an S corporation rather than an LLC, the workaround would result in significant economic distortions that cannot be corrected through special allocations.

As in the LLC example above, MVC still would be required to pay nonresident withholding tax of $9 with respect to each of Vaughn and Carl. In addition, MVC would pay $9 in Maryland income tax with respect to Mary's share of MVC's taxable income. However, because special allocations are not permitted in the S corporation context, the economic burden and tax benefit of the SALT deduction must be shared equally by Mary, Vaughn, and Carl. Accordingly, the $9 Maryland PTE deduction would necessarily be allocated pro rata to each of Mary, Vaughn, and Carl, reducing each of their respective shares of allocable MVC income from $300 each to $297 each. This results in Vaughn and Carl each bearing, on top of their own individual $9 Maryland tax burden, an additional Maryland tax burden of $3 (based on their one-third allocable share of the $9 PTE-level tax resulting from the election into the workaround regime), which should really be exclusively Mary's Maryland tax burden.


In summary, while Maryland's new PTE-level tax certainly offers an opportunity for federal tax savings, the statute appears to limit its applicability to only Maryland residents. While it is not at all clear why Maryland limited the workaround to Maryland residents, the statute in its current form seems to do just that, and the Comptroller's recent guidance confirms that this is the case. This not only deprives non-Maryland residents of the benefits of the new regime, but also creates economic distortions in the case of a Maryland PTE that has both Maryland and non-Maryland resident members, as discussed above. These distortions can be remedied in the case of partnerships and LLCs, but not in the case of subchapter S corporations.

It is of course possible that the Maryland Legislature will at some point extend the benefit of the workaround to non-Maryland residents. In the meantime, practitioners just need to be aware of the issues discussed above and tread carefully.