As previously communicated, recent updates to the State and Local Tax (SALT) workaround issued by the State of California, clarified some of the more troubling provisions of this law. This update should allow taxpayers to take advantage of the new deduction opportunity.
The election and payment for 2021 are due by March 15th. The deduction related to this payment would reduce your federal income for 2022 (since the payment was made in 2022). For example, if your partnership, S Corporation, or trust has $100,000 of income for 2021, the entity could pay 9.3% for each electing partner, shareholder, or beneficiary. It seems like a win for all applicable taxpayers.
However, there are still some open questions that we do not expect to be resolved before the March 15th deadline, and there are cash requirements to consider as well.
The unresolved issues include the applicability to non-operating income from a trade or business. For example, if you own an interest in a partnership that holds investments, it is unclear if this payment reduces your federal taxable income. The current guidance from the IRS gives the impression that taxpayers will get to deduct the amount. Still, historically this expense would likely have been classified as an investment expense (currently not deductible).
There is no harm to making these payments through your pass-thru entity in this situation. Worst case scenario: you get credit for your individual California income tax return payment but will not get a deduction on your federal tax return.
What you do need to consider is the cash flow requirements. Let’s assume you have fully paid your 2021 California tax already (you made your Q4 estimated payment). Electing into AB150 will require your pass-thru entity to pay 9.3% on your 2021 income. This will result in a large overpayment on your California return, but you will get a refund once you file your return.
The second piece to the cash requirements relates to 2022. If you want to elect into AB150 for 2022 and elect for 2021, you need to pay 50% of the 2021 tax as an estimate on your 2022 tax by no later than June 15th.
The deduction resulting from electing into AB150 could result in a significant federal benefit. In our example above, the $9,300 payment made (on the $100,000 income) could result in a decrease in your federal tax of approximately $3,500. If you don’t qualify for the deduction, you have only temporarily lost the use of your money.
Taken by itself, this is probably enough reason to make the election. If you have the available cash to meet these payment requirements, it is probably in your best interest to make the election.
Please contact us if you would like our help with making the election and remitting the payment, but hurry because the deadline is March 15th, 2022.
About the Authors
David Troost, CPA, Director
Tax, Technology Industry
David Troost is a Tax Director at KROST. He has spent his career being a client advocate. As a trusted business partner to his clients, he has helped them meet their objectives by serving as a sounding board for decisions. David’s area of expertise includes federal and multi-state tax compliance and consulting for individuals, partnerships, and corporations. » Full Bio
Lou Guerrero, CPA, MBT, Principal
Tax, Tax Specialty Services, Financial Services
Luis (Lou) A. Guerrero, CPA, MBT is Vice President of KROST CPAs and Consultants. As the Tax Practice department leader for KROST, Lou is responsible for the overall tax function of the firm and specializes in clients in the Financial Services sector (hedge funds, money managers, private equity), family office and high net worth individuals, Real Estate, Food Service (restaurants and related), Technology (including manufacturing and distribution) and professional service firms. » Full Bio