By Russell W. Hall, CFP®

California recently passed a bill that may help certain business owners, so read on if you have a partnership, LLC, or S corporation headquartered in that state.  This is also a timely issue, with the first deadline coming up on December 31.

SALT Limitation

Since 2017, when the Tax Cuts and Jobs Act was passed, the federal deduction for state and local taxes (SALT) has been limited to $10,000.  Coupled with the increased standard deduction, this left many taxpayers in California unable to deduct the full amounts of the California taxes they were paying.

AB150

Assembly Bill 150 creates the California Pass-Through Entity tax (PTE).  This attempts to circumvent the SALT limitation for certain businesses – partnerships, limited liability companies that are treated as a partnership, and S corporations (pass-through structures).  For those qualified businesses, owners can elect to have the company pay their share of the tax at the entity level.  The election can be made for each individual owner, so not all owners have to be treated the same. 

This irrevocable election is available for tax years 2021 to 2025, after which the SALT limitation currently expires.  The entity needs to make the election on a timely filed tax return, and has to pay the PTE tax in a timely manner to qualify.

How It Works

At first glance, utilizing the PTE tax doesn’t appear to save out-of-pocket taxes.  California income tax still has to be paid, whether by each owner or the entity itself. 

However, the real difference is at the federal level.  When the entity pays the tax, it then passes along a tax credit to each owner that reduces their state tax liability.  That in turn reduces the amount of state and local taxes to be claimed on the federal tax return, in effect bypassing the $10,000 limitation.

AB150 is still new, and there are kinks to be ironed out.  For instance, there’s no set way for each owner to give their consent and opt in to the PTE.  However, we think this could be very valuable for owners in eligible businesses – in fact, we’re looking at taking advantage of it ourselves as small business owners!

If you’d like to discuss AB150 and how it might affect you, we suggest you talk to your tax preparer as soon as possible.  This year’s payment would need to be made before 12/31 to be deducted on the 2021 tax return.

For more information, schedule a 15-minute discovery call with a fee-only financial advisor.