California now joins several states that have created a pass-through entity tax (PTE tax) providing qualified owners a workaround of the federal $10,000 limit on the state and local tax deduction. California recently passed Assembly Bill 150 (AB 150), which allows qualified pass-through entities (PTEs) to pay tax on their individual, trust, or estate owners’ share of the entity’s qualified net income at the entity level. It also allows these owners, “qualified taxpayers”, to claim a credit for the tax paid on their California personal income tax return, subject to limitations. This means a qualified taxpayer may reduce their federal taxable income by the amount of tax paid and may claim a California credit equal to the amount of the entity tax paid on their share of the entity’s income.
Eligibility
For taxable years beginning on or after January 1, 2021, and before January 1, 2026, PTEs may annually elect to pay an entity level state tax on income. The PTE tax requires an annual irrevocable election on an originally, timely filed return. Aqualifying PTE is an entity taxed as a partnership or S corporation, and does not include a publicly traded partnership, an entity permitted or required to be in a combined reporting group, or an entity that has a partnership as a partner, member, or shareholder. A qualified taxpayeris a partner, member, or shareholder of an electing entity who is an individual, fiduciary, estate, or trust subject to California personal income tax. A qualified taxpayer does not include a disregarded business entity and its partners and members, corporations, or partnerships.
PTE Tax and Credit Calculation
The elective PTE tax is 9.3% of the entity’s qualified net income, which is the sum of the pro rata or distributive share of each qualified taxpayers’ income subject to California personal income tax. The distributive share of income of corporations, disregarded entities, and any other non-qualified taxpayers are not included in the PTE tax base. A qualified taxpayer may claim a nonrefundable credit for the tax paid on the qualified taxpayers’ pro rata or distributive share of the qualified entity’s qualified net income. Any unused credits can be carried over by the qualified taxpayer for up to five years.
PTE Tax Payment Due Dates
For taxable years beginning on or after January 1, 2021, and before January 1, 2022, the PTE tax is due on or before the due date of the original return ignoring any extensions. The election must be made by the PTE when the return is filed. For taxable years beginning on or after January 1, 2022, the greater of 50% of the PTE tax paid in the prior year or $1,000 is due by June 15 of the taxable year. The remainder of the tax must be paid by the original due date of the PTE return ignoring extensions. The PTE may not make an election if the initial payment is not made by June 15.
Key Considerations
- For calendar year taxpayers, the PTE payment for tax year 2021 is not due until March 15, 2022. However, in order to take a federal tax deduction on your 2021 taxes, the PTE must make the payment by December 31, 2021.
- For tax years beginning on or after January 1, 2022, a PTE tax election is invalid unless the first PTE tax payment has been made by June 15 of the taxable year.
- The PTE tax election is required to me made annually on or before the due date of the qualified entity’s tax return and the PTE tax election is irrevocable for the tax year once made.
- There are limitations related to California’s Tentative Minimum Tax that limit this benefit for some taxpayers. We may need to run a tax projection to see if you would benefit from paying this elective tax through your qualified PTE.
Additional guidance on AB 150 is sure to come. We are following the developments closely and will keep you updated. To assess if this new provision is right for you and your business, contact us. We will run projections and assess if it is right for you.
Written by Bryan Snyder and Carolina Escobedo