Potential Benefits for California Pass-Through Entities (PTEs) as State Implements SALT Workaround
California has joined the growing list of states that are implementing new Pass-Through Entity (PTE) taxes as a workaround to the federal state and local tax (SALT) deduction cap of $10,000. The new law applies to S corporations, as well as partnerships and limited liability companies, which were initially left out of the proposed legislation. For tax years beginning on or after January 1, 2021, and ending on December 31, 2025, entities will be paying an entity-level tax on the electing owners’ income, for which they are granted a full credit against their personal California income tax liability. The PTEs are entitled to a federal deduction for the payment of the California tax.
The new law specifically provides that an eligible PTE must:
- Not be a publicly-traded partnership;
- Not be included, or permitted to be, in a combined California tax group; and
- Be owned by either individuals, trusts, estates, fiduciaries or corporations (i.e., excluding tiered partnerships).
The PTE tax is elective annually on an individual partnership/shareholder basis. Therefore, each owner can choose whether or not to opt in any given year. The consent of all owners is not required to elect in, however, once the partner makes the election, it is irrevocable for that year. Basically, electing PTEs pay a 9.3% tax on the owners’ qualified net income as follows:
- For California residents, on all their distributive share of income.
- For nonresidents, only on their California-sourced share of income.
Electing owners are eligible to claim a credit against their California taxes for their respective share of the PTE tax paid. In general, unused credits may be eligible for a 5-year carryforward.
Because the federal SALT deduction limitation sunsets on December 21, 2025, California’s PTE tax will similarly expire as of that date, or automatically be repealed if the cap is lifted earlier.
If you operate a pass-through entity in California, the state’s new PTE tax regime may be of benefit to you. Please contact Alan Goldenberg, Principal and Leader of Anchin’s Tax Controversy and State and Local Tax groups, or your Anchin Relationship Partner, for more information.