California SB 113 Expands Pass-Through Entity Elective Tax Benefits
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 pass-through entities to elect to be taxed at the entity level. On July 16, 2021 California Governor Newsom signed Assembly Bill (AB) 150 into law, which permitted a similar workaround for certain pass-through entities, such as S-Corporations, partnerships and limited liability companies, for tax years beginning on or after January 1, 2021 and through tax years prior to January 1, 2026.
Under AB 150, pass-through entities could elect to pay a 9.3% income tax, as long as the pass-through entities did not include owners that were partnerships, were not part of a combined reporting group, and were not publicly traded. The election is irrevocable and must be made annually. Owners of pass-through entities that paid personal income tax were eligible to claim a credit equal to the tax paid by the pass-through entities.
While AB 150 was a step in the right direction for many California residents and investors that sorely missed their pre-TCJA SALT deductions, the many nuances to the law left much to be desired. Flash forward to yesterday, when California Governor Newsom signed Senate Bill (SB) 113 into law, greatly expanding the benefits of the elective pass-through entity tax:
- Partnerships with partnership owners are now eligible to make the election. The tax cannot be paid on behalf of the partnership owner.
- Single-member limited liability companies that are pass-through owners and are disregarded for Federal tax purposes are eligible to claim the elective tax credit. Single-member limited liability companies that are disregarded for Federal tax purposes are still ineligible from making the election.
- The tentative minimum tax limitation on the elective tax credit is repealed for tax years beginning on or after January 1, 2021.
- The elective tax credit would be applied against the net tax after taking into account credits for taxes paid to other states for tax years beginning on or after January 1, 2022.
Thanks to Olga Zarney and Monica Heyman for their late-night contributions and consultation on this blog post!
Source: California Legislative Information
- Carey M. Heyman, CPA
- Managing Principal of Industry - Real Estate
- CliftonLarsonAllen LLP
- Century City (Los Angeles)
Carey is the Managing Principal of the Real Estate Industry at CLA. He is a trusted advisor with close to 20 years of experience providing accounting, assurance, tax, and consulting services to real estate industry owners, operators, family offices, developers and syndicators. Carey has a strong track record of helping clients build and retain capital by leveraging tax- and cost-saving strategies and employing tax credits and incentives. He also consults with high net worth individuals, large family groups, and owners of closely-held businesses on all aspects of tax planning, estate planning, and retirement planning.
I can’t quite see how payments the entity makes on behalf of an individual will not be income to the individual personally under Federal income tax principles.