The Tax Cuts and Jobs Act (TCJA) passed in late 2017 put a $10,000 limit on the amount of state and local taxes (SALT) individuals could subtract as itemized deductions. As a workaround, many states have enacted legislation to allow certain pass-through entities (PTEs) to be taxed at the entity level for state taxes. This allows PTEs, such as S corporations and partnerships, the ability to deduct their tax payments at the federal level as a business expense. This essentially bypasses the $10,000 deduction limit at the shareholder/member level. The state income taxes paid by the PTE are then taken as a state income credit which can be used to offset state income taxes due on the owner’s tax return.
On July 16, 2021, California Governor Gavin Newsom signed Assembly Bill 150, allowing this workaround for S corporations and partnerships for tax years beginning on or after January 1, 2021. Certain PTE’s can elect to pay 9.3% income tax. To be eligible for the election, California requires the following payments:
If Payment 2 is made before December 31st of the taxable year of the election it will be deductible on that year’s PTE tax return. If payment 2 is made after the December 31st date, that payment will be deductible on the next year’s tax return. The election must be made on a timely filed return (including extensions) and is irrevocable for that year. For California purposes (each state has different rules), each owner within an eligible PTE can consent to have their share of income subject to the PTE tax. If an owner does not consent, it doesn’t preclude other owners from making the annual election to pay the tax. The tax withheld will be computed based on the electing owner’s distributive share of pass-through income.
If you would like to do some analysis to measure the potential benefit of making the election, please contact our office.
Aura Advisors is a boutique tax consulting, compliance, and representation firm working with affluent individuals and owners/officers/founders of start-up/emerging growth companies. Building connections beyond the code.