Pass-Through Entity Tax

With the passing of Assembly Bill 150 on July 16, 2021, California has created an elective tax that certain pass-thru entities can pay on behalf of their owners. For tax years beginning on or after January 1, 2021 and before January 1, 2026, “qualified entities” can elect to pay an optional tax, and qualifying electing partners will receive a nonrefundable credit against their resident or non-resident California tax liability. This pass-thru entity (PTE) tax will be in effect until January 1, 2026 or the repeal of the SALT deduction cap, whichever comes first.

The idea behind the enactment of these taxes is that if the PTE is liable for and pays the tax, it can receive a federal deduction for state taxes paid. That deduction reduces the federal ordinary income that passes through to the K-1 owners, thereby reducing their federal income tax liability. This regime is designed to circumvent the $10,000 federal cap on the deductibility of state taxes adopted by the Tax Cuts and Jobs Act of 2017.

Who is Eligible?
Entities taxed as an S corporation or partnership (including limited liability companies) may make the election as long as they:
– Do not have any owners that are partnerships;
– Are not permitted or required to be included in a combined reporting group; and
– Are not publicly traded partnerships
Each partner of an entity may separately elect to be subject to the PTE tax. A qualifying taxpayer that does not elect into the PTE tax does not disqualify the qualifying entity from making the election to pay the PTE tax.

How to make the Election
Entities may make the election on an original, timely filed return. The election is irrevocable.

Tax Rate
The PTE tax is calculated on the qualified net income of the qualified entity at 9.3%.

How does the Credit work?
Owners that elected into the PTE tax are entitled to a credit against their California income tax in an amount equal to the elective tax paid on their behalf. If the credit allowed exceeds their net tax due, they can carry over the excess for up to five years.

Payment of the Tax
For the 2021 tax year, the tax is due by the due date (without regard to any extension) of the original return that the qualified entity is required to file for the taxable year of the election (March 15, 2022 for calendar year taxpayers).

For tax years 2022 through 2025:

  • At least 50% of the elective tax paid the prior taxable year or $1,000, whichever is greater, is due by June 15 of the taxable year of the election; and
  • The balance of the elective tax is due by the due date (without regard to extension) of the original return that the qualified entity is required to file for the taxable year of the election.
    If an entity does not make that first payment by June 15, it may not make the election for that tax year.

Items we are looking into to or waiting for guidance

  • If your entity has a partner that causes the entity to be ineligible, should ownership of entity be looked at and possibly changed to receive these benefits?
  • You have operations in other states – does that state comply with PTE tax? There currently are approximately 20 states that have adopted the PTE tax deduction. Each state has its own rules and regulations so we may have to look deeper into your situation.
  • Cash basis taxpayers – Can you pay the PTE tax before the end of 2021 to get the deduction in 2021? It is unknown at this time.