California Approves Workaround to State and Local Tax Deduction Limitation
On July 16th, the Governor signed AB 150, a budget trailer bill containing language outlining California’s state and local income tax (SALT) workaround via an elective passthrough entity tax. More specifically, for tax years 2021 through 2025, pass through entities (PTE) can make an election to pay a passthrough entity tax equal to 9.3% of qualified net income. The advantage of making this election is that it allows these passthrough entities to pay and fully deduct California income tax at the entity level and allocate the tax paid as a credit against the California personal income tax of the partners/shareholders. The result of the election to pay tax at the entity level is to avoid the $10,000 SALT limitation that applies to individuals and trusts.
Details of the Workaround
|· Entities that are taxed as partnerships that do not have partnerships as partners qualify as do S Corporations. Single member LLCs and publicly traded partnerships do not qualify. Accordingly, some partnerships that do not presently qualify will need to implement restructuring strategies.
· The tax only applies to PTEs and their owners and does not apply to other income such as wages.
· The election is made annually, it’s irrevocable, and it can only be made on an original, timely filed return.
· For the 2021 year, the passthrough entity tax is due March 15, 2022 for calendar year taxpayers.
· For the 2022 through 2025 tax years 50% of the prior year tax is due on June 15th of the taxable year and the remaining is due by the entity’s original filing date deadline.
Since taking advantage of the new law may require structural changes as well as other immediate planning, it is important that the above is addressed promptly for many partnerships and S corporations. Also, other states have passed or are working on similar legislation that could affect taxpayers with multi state filing requirements.
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Issues to consider when making the election include that the PTE tax is a flat 9.3% and only taxpayers that are in the higher tax bracket will receive the full benefit. In addition, since the credit can only be taken against S Corporation or partnership income, if taxpayers have offsetting losses from other entities the credit may be limited. Overpayments can be carried over to future years but are not refundable. Finally, there is uncertainty how California will treat PTE taxes paid to other states for taxpayers who file in multiple states and whether a mechanism to pre-pay the tax in 2021 will be provided.
Should you have questions or any other concerns, please give us a call or send an email.
We will continue to send updates on Tax Alerts and other developments, as necessary.
Brian serves as the Director of Tax at HKG. With more than 10 years of experience, he began his accounting career at KPMG, LLP working in the federal tax group. He later joined Moss Adams, LLP providing tax services to midsize manufacturing clients. Brian provides a full range of tax services to a variety of industries including manufacturing and banking.