California Pass-through Entity Tax
On July 16, 2021, California Governor Gavin Newsom signed Assembly Bill 150 (A.B. 150) into law, providing a new tax election for pass-through entities as a “workaround” to the federal $10,000 state and local tax (SALT) deduction limitation for individual taxpayers.
California is now among the states that have enacted workarounds for the SALT deduction limitation in response to IRS Notice 2020-75, which clarifies U.S. Treasury’s intent to issue proposed regulations allowing the deduction of state and local income taxes paid by pass-through entities as part of the computation of non-separately stated taxable income or loss.
The new California law is applicable for tax years beginning or after January 1, 2021, and ending before January 1, 2026, and allows for qualifying pass-through entities (partnerships, LLCs taxed as partnerships, and S corporations) doing business in the state, and required to file a California tax return, to pay a 9.3% tax based on electing owners’ distributive share of income. Electing owners then receive a non-refundable credit for taxes paid, against their state personal income taxes. The advantage of making this election is that the entire amount paid for state taxes on pass-through income is deducted at the entity level, reducing the amount of electing owners’ income, thereby not subjecting state taxes to a deduction limitation.
The election is made on an annual basis, is irrevocable, and can only be made on an original, timely filed state tax return.
For calendar tax year 2021, one payment of 9.3% on electing owners’ income will be due on March 15, 2022; for tax years 2022-2025, payments must be made in two installments, as follows:
- The greater of $1,000 or 50% of taxes paid in prior year will be due June 15 of the taxable year of the election; and
- The remainder of the tax will be due on or before the due date of the original return (March 15 for calendar year taxpayers).
The pass-through entity is disallowed from making the election for the taxable year if the payment due June 15 is not made.
Consenting owners can then claim a non-refundable credit on their CA tax returns for the amount paid on their share of income; excess credits will be carried forward for five years.
For further assistance, please contact your Marcum State and Local Tax professional to address any questions regarding issues related to California’s elective pass-through entity tax.