Could the California State Tax Workaround (AB 150) help you? : 2021 : Articles : Resources : CLA (CliftonLarsonAllen)
- AB 150 was adopted on July 16, 2021, allowing qualified intermediate entities to make this election, which must be made annually on a timely filed statement.
- Each member of the qualifying entity must elect separately.
- New tax legislation passed in February 2022 clarified PTE eligibility and more.
At a Glance: The Latest Updates to the State’s Tax Workaround
With the adoption of SB 113, the following changes come into effect in 2021:
- Qualified PTE now includes PTEs with partnership owners
- Owners of federal entities skipped from PTEs are now eligible taxpayers and can participate in the PTE election and claim a PTE credit
- Income taxed under the PTE option now includes guaranteed payments made to owners
- PTE credit can now be used to offset interim alternative minimum tax
Additionally, beginning in 2022, the PTE credit can be used against California personal income tax after the credit for taxes paid to other states.
The Tax Cuts and Jobs Act (TCJA) passed in late 2017 limited the amount of state taxes individuals could evade as itemized deductions. Since then, many states have enacted a workaround to the $10,000 state and local income tax (SALT) deduction cap by allowing certain flow-through entities (FTEs) to be taxed at the state and local income tax (SALT) level. entity for state taxes. This allows PTEs, such as S corporations and partnerships, to deduct their federal tax payments as business expenses, essentially bypassing the owner-level SALT deduction limit. This is especially beneficial for PTE owners who are limited by the $10,000 limit or who take the standard deduction on their individual return.
On July 16, 2021, California Governor Gavin Newsom signed Assembly Bill 150 into law, authorizing this workaround for S corporations and partnerships for tax years beginning on or after January 1, 2021. On February 9, 2022, the Governor approved Senate Bill 113, which made favorable changes to tax avoidance legislation (generally effective for 2021).
PTEs can elect to pay 9.3% income tax as long as they are not part of a combined filing group and are not listed on a stock exchange. With the passage of SB 113, PTEs with a partnership or disregarded federal entity owners are now eligible owners. Owners of entities that pay personal income tax can claim a non-refundable credit equal to the tax the entity pays. The workaround will be in effect for tax years beginning before January 1, 2026 to match the timing of the federal deduction limit law.
Election and appropriations
The election is irrevocable and must be made each year on the original, timely filed return in the form and manner prescribed by the Franchise Tax Commission. Each owner within a qualifying PTE may consent to having their share of income (including guaranteed payments) subject to PTE tax. If one owner does not consent, this does not prevent other owners from making the annual election to pay the tax. The tax paid will be calculated on the basis of the distributive part of the passed on income of the elective owner.
In the event that the PTE credit allowed exceeds the net tax reported on the owner’s return, the excess will be carried forward to reduce tax in the next tax year and one of the following four years (for a total of five years). Previous legislation limited the credit to ordinary tax. However, SB 113 allows the credit to also reduce interim alternative minimum tax.
Per SB 113, the PTE credit is now set in the ordering process to fall after the credit for taxes paid to other states beginning with the 2022 tax year. This will likely be an issue for the year tax 2021, because the order would be to use the PTE credit before to use the credit for taxes paid to other states. Although the PTE credit is allowed to be carried forward, the credit for taxes paid to other states is not.
Estimated tax payments
For tax years beginning on or after January 1, 2021 and before January 1, 2022, PTE tax is due on or before the original due date of the return. For tax years beginning on or after January 1, 2022 and before January 1, 2026, the PTE tax is due in the following brackets:
- The first installment is due by June 15 of the annual election tax year, which must be the greater of 50% of the optional tax paid in the previous tax year or $1,000 .
- The second installment is due no later than the due date of the original declaration for the qualified entity, without regard to any extension (March 15 for a civil entity).
PTEs that have already made tax distributions to owners for estimated Q1 and Q2 tax payments will likely go out of pocket twice to pay tax, as the estimated tax paid at the individual level is not not automatically applied to the PTE tax that is due.
How can we help you
Determining whether or not to make this choice can be complicated, depending on where your entity does business and the location of the owners. Our state and local tax professionals can help answer your questions about how the calculation works and whether or not this choice might be beneficial for you. We are here to know you and help you.