Certain Pass-Through Entities Can Now Bypass Federal SALT Limitations Passed in 2017
California Governor Gavin Newsom signed into law Assembly Bill 150 on July 16, 2021. In terms of tax relief measures, this is great news for pass-through entities (PTEs). It now allows them to claim a state income tax deduction for all taxes they pay to the state of California.
A Summary of the SALT Cap Deductions for PTEs
Before the 2018 tax year, individual taxpayers were allowed to deduct some state and local taxes without limitations on the federal level. However, the Tax Cuts and Jobs Act (TCJA) passed in 2017 put a limit of $10,000 for state and local taxes. This put a huge damper on the largest itemized deduction for many taxpayers.
Taxpayers in states with particularly high taxes, such as California, were hit the hardest by TCJA. In some cases, their tax rates went up by over 50 percent. Thanks to California Assembly Bill 150, there is now a workaround using PTEs to decrease the heavy impact of the previous deduction limitations. The Small Business Relief Act within the new bill now allows qualified PTEs to deduct 9.3 percent of qualified net income for federal tax purposes through the 2025 tax year. The result is that any PTE can bypass the federal SALT limitations passed in 2017.
Why This Is Important
In the state of California, all owners of qualified PTEs that end up incurring over $10,000 a year of personal state tax liability can now increase their state taxd eduction indirectly on their personal income tax return. This works to override the $10,000 individual limitation and bring down total Federal income, going into effect for the 2021 tax year. California Assembly Bill 150 will apply so long as it is not repealed. However, if it is repealed, it will no longer apply on the following January 1st.
Who Does This Benefit?
The qualified PTEs that can take advantage of this bill are S-Corporations and Partnerships. They can annually elect to bypass the $10,000 limitation by filing their tax return on time without regard to extensions. For publicly traded partnerships, entities with a partnership owner, and entities permitted or required to report in a combined group, Assembly Bill 150 does not apply.
Eligible PTE owners can choose to subject their share of income to the pass-through entity tax. Each PTE owner can individually decide to apply their share of the entity’s income even if another owner does not consent. The bill includes individuals, corporations, trusts, and estates as eligible entity owners. It does not include partnerships. If you are an individual operating a business as its sole proprietor, it could be wise to convert to an S-Corporation or Partnership to capitalize on the bill.
An Additional Nonrefundable Credit
Qualified PTE owners can also opt to claim a nonrefundable credit for the taxes paid on their distributive share of the entity’s net income. All California residents, part-time residents, and non-residents can apply for this credit in full. They can also roll over unused credits for as many as five years.
Schedule a free consultation with us today to discuss Assembly Bill 150 and how we can best prepare you.