CALIFORNIA ENACTS CHANGES TO PASS-THROUGH ENTITY TAX
California just enacted Senate Bill 113 (SB 113), which made the State’s new pass-through entity tax (PTE) much more attractive for certain owners of S corporations, partnerships, and LLCs taxed as an S corporation or partnership. This new bill is effective retroactively to January 1, 2021, and has removed many of the limitations and drawbacks from prior legislation (Assembly Bill 150).
A qualifying entity elects to pay the tax at the entity level and reduces the amount of federal K-1 income passed through to you. The entity is not subject to the $10,000 state and local tax limitation (SALT) enacted by the Tax Cuts & Jobs Act, so it can claim a significantly higher tax deduction than you can on your individual return. Plus, you get to claim up to a 100% credit on your California return for your share of the tax paid by the entity.
The payment of this tax is due March 15, 2022 and will reduce your federal taxable income in the year of payment, while the state tax credit will be reflected on your 2021 California schedule K-1. Each qualified owner separately elects to be subject to the PTE. If one elects to not be included, the entity can still pay the PTE for others.
Prior to SB 113, there were significant limitations that made this option unattractive for many taxpayers. However, this new law greatly improved this elective tax option by:
- Eliminating tentative minimum tax limitations;
- Including guaranteed payments paid to partners/LLC members in the tax base; and
- Expanding which entities can make the election and the types of owners for whom the tax may be paid.
If you are a shareholder, partner or member of an S corporation, partnership, or LLC taxed as an S corporation or partnership, you might be able to significantly reduce your tax liability as a result of this greatly expanded SALT workaround.
This may be quite beneficial, but there are a lot of factors to consider in evaluating whether it makes sense for a pass-through entity to make the election, and whether you should consent to have the entity pay tax on your share of the entity’s income.
As always, please connect with us for guidance related to your specific tax needs or questions.