On May 17, 2021, South Carolina Gov. Henry McMaster signed Senate Bill 627, establishing the state as at least the thirteenth state to adopt a pass-through entity tax intended as a workaround to the federal $10,000 limitation on the state and local tax (SALT) deduction. The election is effective for tax years beginning on or after Jan. 1, 2021. The law allows partnerships and S corporations, including limited liability companies taxed as partnerships or S corporations, to elect to file and pay taxes on active trade or business income at the entity level. Those pass-through entities making the election will be taxed at 3% of their net income that is allocated or apportioned to South Carolina. The South Carolina election must be made annually. Partners and shareholders of entities making the election do not recognize income that is subject to the entity level tax. The new law is silent with respect to whether South Carolina will allow partners and shareholders credit for taxes paid in another jurisdiction.
At 3%, the South Carolina entity-level tax is imposed at a rate well below the highest individual tax rate (7%) for the state. The rate differential may impact a partnership or S Corporation’s decision to make the election. With the enactment, South Carolina joins a growing numbers of states that have adopted similar workaround laws: Alabama, Arkansas, Connecticut, Georgia, Idaho, Louisiana, Maryland, New Jersey, New York, Oklahoma, Rhode Island and Wisconsin. Several other states are still considering elective entity-level taxes in 2021 including California, Illinois and Massachusetts.
Taxpayers are cautioned that the workaround may or may not be the answer to addressing the federal SALT deduction limitation. Taxpayers should also consider that changes in the federal SALT deduction or other state and federal tax provisions may further impact whether the election is beneficial. Taxpayers are encouraged to contact their state and local adviser to discuss the South Carolina and other state SALT deduction limitation workarounds.