In July 2021, the California Assembly enacted California Assembly Bill 150 joining the numerous other states (including New York, New Jersey, Connecticut, Maryland, Rhode Island, etc.) that have enacted a pass-through entity (“PTE”) tax.
The new law, applicable to tax years beginning on or after January 1, 2021 and ending before January 1, 2026, allows for many PTEs to pay an entity level tax based on electing individual owners’ share of income, and then grants the owners a credit against California personal income tax for the full amount of tax paid at the entity level on their distributive share of California taxable income. The election also creates a deduction on the PTE’s federal income tax return because the state taxes paid by the PTE reduce the federal taxable income that its electing owners report on their federal income tax return.
PTE Qualification: In order for a California PTE to qualify for this election:
- The owners must consist solely of individuals, fiduciaries, trusts, estates, or entities taxable as corporations. A qualifying PTE cannot have a partnership as an owner.
- The entity cannot be a publicly traded partnership.
- The entity cannot be included in a California combined report.
PTE Elective Tax: Eligible PTEs will pay a 9.3% tax on the total of each consenting owner’s pro-rata share of the entity’s income subject to California tax. For California residents, it includes all of their distributive share of income. For nonresidents, it includes all of their distributive share of California source income. An individual owner can determine whether or not they want their income included when the entity makes this election. The consent of all owners is not required in order for the entity to make the election.
Timing of Election and Tax: The election is irrevocable, and must be on an annual basis on a timely filed return for the year of the election. For tax year 2021, the tax is due on or before the due date of the entity’s return, without regard to extensions. For tax years 2022 through 2025, the elective tax is due in two installments: the greater of $1,000 or 50% of the tax paid in the prior year is due by June 15th of the taxable year of the election, and the remaining amount is due on or before the due date of the original return (without regard to extensions).
Owner Credits: Consenting owners of the PTE making the election will claim a credit on their California tax return equal to 9.3% of tax paid by the PTE on the owner’s share of income subject to tax in California. However, credits in excess of tax due are allowed to be carried forward for up to five years.