For taxable years beginning on or after January 1, 2021, and before January 1, 2026, qualifying pass-through entities (PTEs) may annually elect to pay an entity level state tax on income. Qualified taxpayers receive a credit for their share of the entity level tax, reducing their California personal income tax.
This will allow owners of pass-through entities to pay California personal income tax through that entity. The owner will receive a deduction for the California personal tax paid through the entity in the form of lower income reported to them on their K-1.
This allows the owner to receive a full deduction of the California personal income tax paid. If the California personal income tax was paid directly from the individual owner, the deduction would be limited to $10,000. The $10,000 limit includes this California personal income tax, real estate tax and other local taxes. Because of this, very little in terms of California personal income tax is usually deductible as an itemized deduction.
While this strategy is beneficial, there are some requirements that make implementation difficult:
o Each owner must pay 9.3% of their share of income regardless of the owner’s personal tax rate. This means they could potentially overpay their tax for the year.
o The tax paid is claimed as a nonrefundable credit on the owner’s personal California tax return. If the credit creates an overpayment on the owner’s personal California tax return, it likely will not be refundable. This means you will not receive a refund in that year. However, the credit can be carried forward and used for five years. This means you can use the credit in the next five years if you do not have overpayments in those years.
o In 2021, tax payments have already been made and it could cause large overpayments that are not refundable. The overpayment could be used in the next five years, but this could cause cash flow issues.
o In 2022 – 2025, $1,000 or 50% of the prior year tax (whichever is greater) must be paid by June 15th. If prior year tax was unusually high, this could cause large overpayments that are not refundable in the current year.
2/9/22 Update from Spidell’s Flash E-mail:
“The Governor today signed SB 113, which expands the passthrough entity elective tax benefits by:
- Repealing the tentative minimum tax limitation on the Passthrough Entity Elective Tax Credit;
- Allowing partnerships/S corporations/LLCs with owners that are partnerships to make the election (although the tax can’t be paid on behalf of the partnership owner);
- Allowing SMLLCs that are passthrough entity owners to claim the Passthrough Entity Elective Tax Credit (although SMLLCs are still prohibited from making the election themselves); and
- Changing the credit ordering rules related to the Passthrough Entity Elective Tax Credit to increase the benefit for taxpayers that claim the Other State Tax Credit (beginning with the 2022 tax year).
Except as noted, these changes will apply to the 2021 tax year.SB 113 also:
- Fully conforms to the federal exclusion of Restaurant Revitalization Grants, retroactive to the 2020 tax year;
- Partially conforms to the federal exclusion of Shuttered Venue Operator Grants, retroactive to the beginning of the 2019 tax year; and
- Repeals the $5 million business credit limitation and NOL suspension for higher income taxpayers for the 2022 taxable year.
The Governor also signed SB 114, which requires employers with more than 25 employees to provide up to 80 hours of COVID-19–related paid supplemental sick and family leave, retroactive to January 1, 2022, through September 30, 2022. There are no provisions that provide tax benefits or credits to employers who provide the supplemental paid leave.”
To read the bills, go to: