How to Deduct 100% of Your State Income Tax

Video Transcription:

Many states have now implemented laws that allow you to deduct your state income taxes on your federal tax return. What’s significant about this is that the IRS has actually published a notice blessing this strategy. The general idea is that states will give you the option to elect to pay the tax at the entity level, making it an ordinary and necessary business expense that can be deducted on your federal return, and then you can get a state tax credit for the payment. The state still gets their money, which is of course important to them, and their residents are happy because it’s still deductible on their federal tax return.

For example, California passed Assembly Bill 150. This bill is effective starting with the tax year 2021 and allows qualifying entities, which are Partnerships and S-Corps, to make an election to be taxed at a rate of 9.3% at the entity level. This election is made separately by each owner. You’ll then pay the tax on net income at the entity level and take the deduction on the business’s federal return. Then you’ll get a tax credit on your personal tax return for this tax payment. If you paid more at the entity level than due at the individual level, then you’ll carry forward that credit to future years, and if you paid less than you would have otherwise owed, then you’ll pay the additional tax on your individual return. And the 9.3% tax bracket in California applies to taxpayers with income between approximately $61,000 to $312,000, so it should end up being pretty close to the amount due for many California individuals

Now there’s a ton of states that have passed some version of this and they’re listed below along with the name of the enacted law for each state. You’ll want to take a closer look into the rules for your state or talk with your tax professional because they have different requirements, and they don’t all begin for the 2021 tax year. Though it will often minimize your tax to make the election to pay at the entity level, there are situations where it won’t save you tax or when it will help some of the partners but not the others. So, of course, this goes back to the importance of tax planning for your situation.


Alabama – Act 2021-1
Arkansas – Act 362
Arizona – HB 2838
California – AB 150
Colorado – HB 1327
Connecticut – SB 11
Georgia – HB 149
Idaho – HB 317
Illinois – PA 102-658
Louisiana – SB 223
Maryland – SB 496
Minnesota – HF 9
New Jersey – PL2019, c320
New York – Article 24-A
Oklahoma – HB 2665
Oregon – SB 727
Rhode Island – HB 5151
South Carolina – SB 627
Wisconsin – Act 368

Disclaimer: This information on this site is for educational purposes only and does not constitute professional legal or tax advice.