New Passthrough Entity Law Saves Federal Taxes

Maybe the most important provision of AB 150 (Ch. 21-82) is a workaround for the federal $10,000 state and local tax (SALT) limitation for qualifying S corporation, partnership, and LLC owners.

Elective passthrough entity tax

For the 2021 through 2025 taxable years, a qualified S corporation, partnership, or LLC taxed as a partnership or S corporation that is doing business in California and required to file a California return may elect to pay a passthrough entity tax equal to 9.3% on its qualified net income. This will decrease the federal net income included on the owners’ K-1.1

In essence, this allows the K-1 recipient to reduce federal AGI rather than having a state tax deduction on Schedule A, which would be subject to the $10,000 SALT deduction limit. The owner will report the net income to California, which will not include the tax payment, and also receive a California tax credit equal to the state tax paid by the passthrough entity on behalf of the owner.
Example of making the election: Wanna Save LLC, which is taxed as a partnership, has qualified net income of $100,000. Two partners each have a 50% interest. If both partners qualify and the election is made, the partnership makes a payment of $9,300 to the FTB. The partnership then reports $45,350 (($100,000 – $9,300) × 50%) of net income on each of the federal K-1s. The California returns filed by the partners will report $50,000 of net income from Wanna Save ($45,350 federal net income + $4,650 elective passthrough entity tax paid to California), and a credit of $4,650 against their individual California income tax.

If the federal $10,000 SALT limitation, as it read on January 1, 2021, is repealed, the elective passthrough entity tax will become inoperative on the following January 1. This type of SALT workaround has been approved by the IRS.2
Qualified net income

Qualified net income is the sum of the pro rata share, or distributive share, of income of the entity’s individual, trust, or estate owners that consent to have their share of income subject to the elective passthrough entity tax. The entity may still elect to pay the tax even if some of its owners do not consent. However, the amount of qualified net income will be reduced by the nonconsenting owners’ share of the entity’s income.
Credit for owners

The consenting passthrough entity owners may also claim a nonrefundable credit on the California return for the amount of tax paid on the owner’s pro rata or distributive share of the passthrough entity’s net income.3 The credit is allowed in full for nonresidents and part-year residents, and no proration is required.4 Unused credits may be carried forward for up to five years.

Making the election

The election is made annually, is irrevocable, and can only be made on an original, timely filed return.5

Note: The law does not address whether an extended return will be considered a timely filed return, so we must await further guidance from the FTB.

Only entities taxed as an S corporation, partnership, or an LLC taxed as a partnership or an S corporation are eligible to make the election and only 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.

The passthrough entity tax is in addition to any other tax or fee that the passthrough entity may be subject to.
Paying the tax

The tax is due on the due date of the original return for the 2021 taxable year, without regard to extensions (March 15, 2022, for calendar-year taxpayers).

But this changes for the 2022 through 2025 taxable years. In those years the entity must make two payments. The first payment is due by June 15 of the taxable year, or the 15th day of the six month of the taxable year for fiscal-year taxpayers. The amount due is the greater of:

  • 50% of the elective tax paid for the prior year; or
  • $1,000.

The remaining amount due must be paid by the entity’s original filing date deadline (March 15 for calendar-year taxpayers).

Note: This means that partnerships and S corporations that make this election will be less likely to file their returns on extension.

Example of paying the tax: Partnership A made an election in 2021 and 2022 to pay the entity level tax on behalf of three of its individual partners. In 2021, it paid an entity level tax of $3,000 by March 15, 2022.

For the 2022 taxable year, it must pay $1,500 by June 15, 2022 (50% × 3,000). When it files its 2022 partnership return in 2023 it reports a total entity tax due of $4,000. Partnership A must pay the remaining $2,500 by March 15, 2023.

If the entity fails to pay the amount due by June 15, the entity is prohibited from making an election to pay the passthrough entity tax for that year.
Other AB 150 provisions

AB 150 also provides for extensions and expansions of various tax incentives and grants.6 These credits are discussed in detail in the “New hiring credits enacted” article in this issue. The Golden State Stimulus payments are also discussed in a separate article titled “Second round of Golden State Stimulus payments authorized.”
Miscellaneous provisions contained in AB 150

In addition, AB 150:

  • Increases the amount of allocation of the California Competes Credit for the 2021–22 fiscal year from $180 million to $290 million;7
  • Extends the sunset date for the 15% income and franchise Donated Fresh Foods Credit by five years from January 1, 2022, to January 1, 2027;8
  • Extends the income and franchise State Historic Tax Credit by one year from January 1, 2026, to January 1, 2027;9
  • Extends indefinitely the sales and use tax exemption for sales of diapers and feminine hygiene products;10 and
  • Expands the FTB disclosure provisions to allow the FTB to share information with the California Department of Health Services to assist in identifying individuals who may be eligible for Medi-Cal and/or the Earned Income Tax Credit.11

Not included

What is not included in the budget deal is any additional federal conformity provisions, or a repeal of the NOL suspension or limitation on business credits for large taxpayers that was enacted as part of last year’s budget deal.

  1. R&TC §§17052.10, 19900 et seq.
  2. IRS Notice 2020-75
  3. R&TC §17052.10
  4. R&TC §17055
  5. R&TC §19900
  6. AB 150 (Ch. 21-82)
  7. R&TC §§17059.2, 23689
  8. R&TC §§17053.88.5, 23688.5
  9. R&TC §§17053.91, 23691
  10. R&TC §§6363.9, 6363.10
  11. R&TC §19551.3

About the Author
D. Steven Yahnian has been a member of the California Bar and a practicing Attorney since 1980. He has also been a California CPA since 1984. Mr. Yahnian also holds the CFP® designation.

Mr. Yahnian practices in the following areas of law through YAHNIAN LAW CORPORATION:

  • Estate Planning & Administration
  • Asset Protection Planning
  • Tax Planning, Tax Debt Resolution and Tax Litigation
  • Business & Corporate Law and Planning
  • Real Property Law & Planning

As a CPA/CFP, Mr. Yahnian also has a separate accounting and tax return preparation practice called DSA ACCOUNTING.

Mr. Yahnian is a California State Bar Certified Specialist in the following
• Taxation Law and
• Estate Planning, Trust & Probate Law.

Mr. Yahnian received a B.S. degree in Accounting from USC, a J.D. from Loyola University of Los Angeles School of Law and an LL.M. in Taxation from New York University Law School. He also has a Certificate in Taxation from UCLA (with distinction). Mr. Yahnian also has an MS in Taxation* from UCLA (with Distinction).


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