California approves SALT cap workaround
California’s Gov. Gavin Newsom recently signed Assembly Bill 150 (“AB150”), which created a workaround for the current $10,000 limitation on the deduction for state and local taxes paid for individuals established by the Tax Cuts and Jobs Act (TCJA). AB150 creates an elective tax that allows the taxes on pass-through income to be paid at the entity level. This means owners will be able to bypass the cap’s limitation that could otherwise be applicable.
For tax years beginning on or after Jan. 1, 2021, and before Jan. 1, 2026, qualified entities can make an irrevocable election annually on an original, timely filed return to pay the tax on a qualified owner’s share of net income of the qualified entity. Qualified entities include partnerships, limited liability companies with multiple members treated as a partnership, and S corporations. Disqualified entities are pass-through entities that have a partnership or a disregarded entity as an owner publicly traded partnerships, and entities that are permitted or required to be in a combined reporting group.
Qualified owners must consent to the qualified entity making the election to pay the elective tax at a rate of 9.3% on the qualified owner’s share of net income. Each qualified owner separately elects to be subject to the pass-through entity (“PTE”) tax; if one elects to not be included, the qualifying entity can still elect to pay the PTE tax for others.
The qualified entity pays the elective tax on the sum of the qualified net income, defined in the bill as the “sum of the pro rata share of distributive share of income subject to tax under Part 10 (commencing with Section 17001) for the taxable year of each qualified taxpayer, as defined in Section 17052.10.” Electing qualified owners will receive a nonrefundable credit against their California income tax liability. If the allowable credit exceeds the qualified owner’s California tax liability, the excess can be carried over for up to five years.
The election would be available for tax years beginning on Jan. 1, 2021, and ending before Jan. 1, 2026, when the federal state tax limit is set to expire, or if the state and local tax deduction cap is repealed before the expiration – whichever comes first.
For tax years beginning between Jan. 1, 2021, and Jan. 1, 2022, the elective tax is due and payable on or before the due date of the tax return without regard to any extension of time to file. For calendar year filers, the due date is March 15, 2022.
For taxable years beginning between Jan. 1, 2022, and Jan. 1, 2026, the elective tax is due and payable in two installments. The first installment is due by June 15 of the current tax year of the election and is the greater of $1,000 or 50% of the elective tax paid in the prior year. The second installment is due on or before the due date of the tax return without regard to any extension of time to file.
It is critical that the elective tax is paid in a timely manner. The election may be deemed invalid if the payments are not made based on the above requirements.
The procedure for how a qualified owner provides consent has not been addressed by the Franchise Tax Board. Until guidance is released, we recommend the qualified entity and qualified owner both sign a written consent.
The State and Local Tax Team will continue to monitor the Franchise Tax Board for further guidance.
Subject matter expertise
JD, Principal, Practice Leader, State and Local Tax (SALT) Services
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