California Governor Gavin Newsom has signed a new law, SB 113, enhancing tax benefits to qualifying pass-through entities (PTEs). The new law builds on the tax benefits made available in July 2021 through AB 150.
The original AB 150 law allowed a pathway for PTE owners to work around the $10,000 cap on state and local tax (SALT) deductions imposed by the 2017 Tax Cuts and Jobs Act. AB 150’s workaround, effective for tax years starting on or after January 1, 2021, was an election available to qualifying PTEs including partnerships and S corporations whose owners are individuals, estates, trusts or corporations.
Essentially, the eligible PTE can elect to pay a 9.3% tax on the entity’s qualified net income, which equals the total of the consenting owner’s distributive share of California taxable income. The California tax payment is claimed as a deduction for federal tax purposes in the year paid, thereby reducing the federal taxable income reported on Form K-1 of the consenting owners. Each owner will receive a credit for the tax paid on their California tax return.
The new law SB 113 includes two significant changes. The first change will increase the number of entities that are eligible to make this election by removing the requirement that partnerships could not have any owners who are also partnerships. Under the new law, these partnerships are now eligible to make the election. (However, the tax can’t be paid on behalf of the partnership owner. The partnership owner can make its own election and pay the tax on its tax return.) Additionally, SB 113 expands the definition of “qualified taxpayer” to include single-member limited liability companies (SMLLCs) that are disregarded entities that meet certain criteria.
The second significant change of SB 113 is the repeal of the tentative minimum tax limitation on the elective tax credit. This limitation severely hindered many taxpayers’ ability to utilize the credit in any given year. With the limitation removed, many taxpayers will get an immediate use of the credit in the tax year for which it applies.
Note: The California elective pass-through entity tax will be repealed if federal legislation is enacted that repeals the SALT deduction limitation.
For more information on this and other tax matters, please contact your LLME tax advisor at (858) 455-1200 or by email.