State Tax Deduction Workaround
This year California passed AB 150, which enacts an elective passthrough entity tax (PTET). The idea behind the PTET is to work around the $10,000 SALT deduction limit to an individual’s itemized deductions that came into effect back in 2018.
Simply, qualified passthrough entities may pay tax on a consenting owner’s behalf based on the owner’s distributive share of income. The entity may then include that expense in its deductions, reducing its taxable income, while the owner may also claim a credit on their California tax return for the tax paid. Please note, for cash basis entities the elective tax payment would need to be made before year-end to take the deduction on the corresponding year’s tax return.
Details of the PTET
- Only available to S Corporations and Partnerships whose owners consist solely of individuals, fiduciaries, trusts, estates or entities taxable as corporations.
- The tax rate will be 9.3% of the consenting partner’s pro rata share of income.
- Unused credits can be carried forward for 5 years.
- The election is annual, irrevocable, & can only be made on original timely filed returns.
A few things are still up in the air regarding the California PTET. Primarily, this elective tax will be repealed if federal legislation is enacted that repeals the SALT deduction limitation. It is still uncertain whether the limitation will be repealed before it’s time to prepare 2021 tax returns. Additionally, the California FTB is still in the process of developing forms for entities to elect and pay the tax, and for partners, shareholders, and members to claim the tax credit.
Should the SALT deduction limitation still be in effect at the beginning of 2022, eligible passthrough entities may prepare to make this election on their 2021 tax returns. The payment for the 2021 tax year PTET will be on the filing due date and cannot be extended.
For tax years 2022 through 2025, two payments must be made. The first payment will be made on June 15th of the taxable year and will consist of the greater of 50% of the elective tax paid during the prior year or $1,000. The remaining amount will be due by the original filing deadline, March 15th of the following year. If the June 15th payment isn't made, the entity is prohibited from making the election for that year.
CAPATA will be monitoring the developments as more information comes out and looking for opportunities for our clients to take advantage of this elective tax. Please reach out to us if you would like to explore taking advantage of the PTET.