Assembly Bill 150 (AB 150), signed by California Governor Gavin Newsom on July 16, 2021, permits a qualifying entity to make an annual pass-through entity (PTE) tax election for tax years starting on or after January 1, 2021, but ending before January 1, 2026. The new PTE-level tax option is designed to allow nonresident and resident partners and shareholders of qualifying organizations to deduct state and local taxes in excess of the present $10,000 federal income tax deduction limit.
If the federal statute, which restricts the yearly state and local tax deduction to no more than $10,000, is repealed, AB 150 includes a provision that would render the PTE tax election ineffective before 2026. AB 150 complies with the IRS’s deductibility standards, described in IRS Notice 2020-75.
Qualified Entities
Entities that fit the PTE election qualification criteria are deemed qualified. Limited liability partnerships, limited partnerships, limited liability companies treated as partnerships and S corporations are examples of eligible entities. PTEs authorized or required to be included on a California combined income tax return, publicly traded partnerships, or a PTE with a partnership as a partner or member, are not qualifying entities.
Qualified entities that make the yearly irreversible election on an initial timely filed return, without respect to an extension, agree to pay a 9.3% tax on net income on behalf of eligible partners, members, and shareholders who concur to the PTE election.
California will enable consenting PTE owners to claim a credit based on their pro-rata or distributive share of revenue on their California income tax filings. The credit is not refundable, but it can be carried forward for up to five years if it exceeds the due tax.
For tax years starting on or after January 1, 2022, but ending before January 1, 2026, the qualifying entity must make an advance tax payment equal to, the greater of, 50% of the elective tax paid in the preceding taxable year or $1,000, on or before June 15, for the taxable year of the election. The qualifying entity will not be permitted to make the PTE tax election for that year if the tax payment is not made on or before June 15th. The tax payment is payable by the original due date of the qualifying entity’s California return for the first year (tax years starting on or after January 1, 2021 and ending before January 1, 2022) of AB 150.
New Forms for New Tax
The FTB is looking to create four new forms for the new tax. Each for will perform a different purpose.
- The first form will enable taxpayers to pay the tax by the due date set for the business entity tax return if the business entity tax return is filed by the extended due date.
- The second form acts as a payment voucher. It will be used for the prepayment of the tax due on June 15th of the year, beginning in 2022.
- The third form will be used to identify the amount of the elective tax. It will be completed and filed by the business. It will also show the allocation to shareholders, partners, and other members.
- The fourth form will be filed by shareholders, partners, and members to report the tax credit allocated to them.
Entities Filing Short Year Return
If entities need to pay the PTE now because they are filing a 2021 short-year return, taxpayers may use the Pending Audit Tax Deposit Vouchers to make payments while the FTB develops the PTE optional tax payment vouchers. To make the PTE optional tax payment in 2021, S companies, LLCs, and partnerships can utilize form FTB 3577, 3578, and 3579, respectively.
When making a payment using Pending Audit Tax Deposit Vouchers, it is imperative to mention the tax year as “2021” and tick the “Other” option. Before December 2021, the FTB plans to provide the new PTE elective tax voucher, including directives on making future PTE elective tax payments. The entities can only take advantage of the reduction in net income on the 2021 K-1s for federal purposes if the payment is paid before the end of the entity’s 2021 taxable year.
Taxpayers Making 3rd or 4th Quarter Tax Payments
R&TC 19136(c)(2) states that the penalty for underpayment of estimated tax depends on the tax imposed under R&TC 17041, 17048, and 17062, less credits against tax granted under Part 10. The PTE elective tax is one of the credits that lower the computation of estimated tax payments for purposes of this penalty determination.
This implies that taxpayers who qualify for the credit may lower their third and/or fourth quarter anticipated tax payments to account for increased monies paid via the new PTE election for 2021. It should be noted that the PTE tax credit passed on to owners will lower their 2021 California income tax obligation when paid by the original due date of the pass-through entity’s 2021 California tax return.
Learn More about Pass-Through Entity Tax Information with Windes
Taxpayers interested in learning more about the pass-through entity tax should connect with us today to determine eligibility and how the PTE tax may affect their business filings.