California Approves SALT Deduction Cap Workaround

• August 2, 2021
• Carey M. Heyman, CPA

Since the passing of the Tax Cuts and Jobs Act (TCJA) in late 2017, numerous states have enacted a workaround to the state and local tax (SALT) deduction cap of $10,000 by allowing entities to be taxed at the entity level for their state taxes. The workaround allowed pass-through entities (PTEs), such as S-Corporations and partnerships, to deduct tax payments at the federal level, essentially bypassing the SALT deduction limit available to qualified owners. The workarounds were especially beneficial to PTE owners who had already surpassed the $10,000 limit or were taking the standard deduction on their individual tax returns.

On July 16, 2021 California Governor Gavin Newsom signed Assembly Bill 150, which permits a similar workaround for S-Corporations and partnerships for tax years beginning on or after January 1, 2021 and for those entities that are required to file a California tax return. The PTEs can elect to pay a 9.3% income tax as long as the PTE does not have owners that are partnerships, are not part of a combined reporting group, and are not publicly traded. Owners of the entities that pay personal income tax are eligible to claim a credit that is equal to the tax that the PTEs pay. The workaround will be in effect through tax years before January 1, 2026.

The election is irrevocable and must be made annually on the originally and timely filed tax return in the form and manner as prescribed by the California Franchise Tax Board (FTB). We are still waiting for guidance from the FTB on how to make the election and whether or not “timely filed,” includes extensions (we presume it would, but confirmation from the FTB would be preferred).

Each owner within an eligible PTE can consent to have their share of income subject to the PTE tax. An owner that does not consent, will not preclude the other owners from making the annual election to pay the tax. The tax to be withheld will be computed on the owner’s distributive share of passthrough income.

In the event that the credit allowed exceeds the net tax reported on the owner’s return, the excess will be carried forward to reduce the tax in the following tax year, and any of the succeeding four tax years (for no more than five tax years).

For tax years beginning on or after January 1, 2021 and before January 1, 2022, the 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 increments:

• The first installment is due on or before June 15th of the taxable year of the annual election, which is to be the greater of either 50% of the elective tax paid the prior taxable year or $1,000.
• The second installment is due on or before the due date of the original return for the qualified entity without regard to any extensions (March 15th for a calendar entity).

PTE’s that have already distributed monies to their owners to pay 1^st and 2^nd quarter estimated tax payments, would essentially be out of pocket in order to pay the tax twice; however, PTEs that are partnerships could request the monies to be contributed back into the partnership. A similar idea for S-Corporations would likely not make sense due to the accumulated adjustments account (AAA).

This blog post was authored by colleague Dana Houston. Thank you Dana for the information and timely analysis!

Source: California Legislative Information, Bloomberg Tax

Tags: AB 150, SALT Cap Workaround, Federal and state taxation, including proposed regulations, Year-end tax planning | 1 Comment »