California Pass-through Entity Tax AB 150

Gain an understanding of the CA PTET regime and how best to answer your clients questions.

The pass-through entity tax (PTET) is intended to provide California taxpayers with relief from the current limits on the federal deductibility of state and local tax (SALT) deductions on individual income tax returns. The annual election is optional and effective for tax years beginning January 1, 2021, and is set to expire on December 31, 2025, unless there is a legislative fix that occurs at the federal level before expiration. Specifically, the new tax rules allow a pass-through entity (PTE), such as a partnership or S-corporation, to make California tax payments on behalf of its owners. This effectively allows individual owners of the PTE to bypass the $10,000 limitation on the deduction of state and local taxes imposed on individual taxpayers by the Tax Cuts and Job Act of 2017. This is mechanically achieved by electing to have the PTE pay an entity-level tax of 9.3%, which in turn, is passed through proportionally to the electing owners of the PTE as a credit on their individual tax returns. Moreover, the PTE is not subject to the SALT limitation imposed on individuals. As a result, it is allowed to take a full federal deduction for the California tax payments made on behalf of its electing owners, which proportionately reduces the electing partners' allocable share of income from the PTE and reduces the federal tax liability for the electing owners. This approach was blessed by the IRS in Notice 2020-75. However, many issues should be carefully considered before recommending this election to your clients. These issues include the interplay of the PTE credits with existing California tax credits and withholding, estimated tax payment, and composite return regimes. Your clients are looking to you for answers to their questions regarding the nuances of the CA PTET regime. This presentation will prepare you with the background needed to lead those conversations.