The 2017 Federal Tax Cuts and Jobs Act limited an individual’s annual federal itemized deduction for state and local taxes (“SALT”) to $10,000 per year. California recently passed Assembly Bill 150 that contains provisions that will allow owners of pass through entities (”PTE”) to get around this limitation.
California’s AB150 creates an elective tax of 9.3% on PTE income, like profits from Subchapter S Corps or LLCs, to be paid at the entity level, rather than passing through to the shareholders or LLC members on California K-1s. The Subchapter S shareholder(s), LLC members or partnership partners can deduct this elective California tax on their federal income tax return, without limitation. The bill then allows a non-refundable California tax credit on the individual’s California tax return equal to the amount of the tax paid (9.3% of their pro-rata or distributive share of qualified PTE net income). The bill enables owners to carry forward any unused credit for up to five years after the tax year in which the credit is first claimed
To be of benefit, the taxpayer must itemize and their federal individual income tax rate must be higher than 9.3%. The higher the individual’s tax bracket, the more the benefit. Disregarded entities, such as single member LLCs, do not qualify for the elective tax. The new rule applies to tax years beginning on or after January 1, 2021, and before January 1, 2026. For the 2021 tax year, the California elective tax is due on or before the initial due date of the PTE tax return, generally March 15th, 2022. For subsequent years, the elective tax is due in two installments. The first installment is required to be prepaid by June 15th of the current tax year and equal to the greater of $1,000 or 50% of the elective tax paid in the prior year. The second installment (the balance of the elective payment) is due on or before the initial due date of the tax return.