California has joined the growing list of states that have enacted a SALT cap workaround. California Governor Gavin Newsom recently signed Assembly Bill 150, eliminating the $10,000 cap on the federal deduction for state and local taxes (SALT) paid for pass-through entities. S corporation, partnership, and LLC owners can now deduct the total amount of their state and local tax payments on their federal taxes.
Then and Now
Congress passed the Tax Cuts and Jobs Act (TCJA) in 2017, imposing a $10,000 limit for state and local taxes. This limit hit taxpayers the hardest living in states with high taxes, increasing their effective tax rates between federal, state and local taxes to over 50%.
California AB 150 now allows qualified pass-through entities to pay and deduct an elective pass-through entity tax of 9.3% on its qualified net income. This elective tax is deductible by the entity for federal purposes, effectively bypassing the federal SALT limitation and minimizing this limitation for California taxpayers.
If you own a qualified pass-through entity and incur a personal state tax liability over $10,000 annually, then this bill will allow you to increase your annual state tax deduction on your personal income tax, over the $10,000 individual limitation, and reduce your federal income liability.
For the 2021-2025 taxable years, a qualified S-corporation, partnership, or LLC taxed as a partnership or S corporation can elect to pay a pass-through entity tax equal to 9.3% on its qualified net income. This election will decrease the amount of federal net income paid, and the partners can receive a credit equal to the state tax paid by the pass-through entity on behalf of the owner.
Individual partners can choose not to participate, but the entity can still elect to pay the tax. The partners who consent will get a nonrefundable credit that equals the amount of tax paid by the entity on the partners’ behalf.
The credit is allowed for residents, non-residents, and part-year residents. Unused credits can be carried forward for up to five years.
Notable Details and Dates
The election is annual, irrevocable, and can only be made on an original return filed on time. Qualified entities are only eligible to make the election if:
- The entity’s shareholders/partners are not partnerships;
- The entity is not permitted or allowed to be in a combined return; and
- The entity is not a publicly traded partnership.
For each year beginning January 1, 2022, and ending before January 1, 2026, the elective tax is due and payable in two installments:
- The first installment is due on June 15 of the taxable year of the annual election. Payment is the greater of either 50% of the elective tax paid the prior taxable year or $1,000. If the entity fails to pay the installment on time, the entity is prohibited from making an election to pay the pass-through entity tax for that year.
- The second installment is due on or before the original return for the qualified entity (March 15 for a calendar entity).
If the current federal $10,000 SALT limitation is repealed, the elective pass-through entity tax will become inoperative on the following January 1.
RJI CPAs Can Help
The team at RJI CPAs is available to help you determine if your entity qualifies for the SALT Cap Workaround. Contact us today for a consultation.