The Tax Cuts and Jobs Act passed in December 2017 limited the state and local tax (SALT) deduction for individuals to $10,000. States have worked to find ways around the limit using various methods and gimmicks, which the IRS has rejected until recently. The IRS has issued guidance that allows states to work around the $10,000 limit using pass-through entities, but this required legislative action by the state.
On July 16, 2021, the California Governor signed Assembly Bill 150 (AB150) into law. This legislation allows for certain owners of qualified passthrough entities to work around the individual $10,000 federal limit on SALT deductions for individuals.
The law is retroactive to years beginning on or after January 1, 2021 and continues for years ending before January 1, 2026. AB150 allows for qualified partnerships, limited liability companies and S-Corporations to pay a new elective state pass-through entity (PTE) tax at the entity level and receive a federal tax deduction for state taxes paid on the electing owner’s share of allocable taxable income. The electing owners are then granted a credit against their California personal income tax for the full amount of the tax paid by the entity on their allocable share of California taxable income. This, in effect, allows the individual to deduct the full amount of the state tax paid on their federal return by reducing the PTE taxable income reported on the individual federal tax return and receive a nonrefundable credit for the tax paid on the individual state tax return. The tax for electing owners is 9.3% of the owner’s allocable share of taxable income from the PTE that is subject to tax in California. The credit can be carried forward up to five years.
To receive the deduction and related credit, the qualified PTE must make an annual election for each eligible owner that will be included in the election. Eligible owners include individuals, fiduciaries, estates, and trusts. This credit is not available to owners of PTEs that are not a “qualified owner taxpayer.” This includes entities disregarded for tax purposes (single-member LLC’s), partnerships, corporations which are part of a combined return or publicly traded partnerships. Not every eligible owner is required to be included. The election must be made on a timely filed return and is irrevocable for the year it is made. The election is only valid for the single tax year and a new election can be made each year.
If the SALT limitation is impacting you, the new credit allowed under AB150 may help. Please contact us to discuss your personal circumstances to see if the PTE tax election is right for you.