The California Passthrough Entity Elective Tax Credit (CA PTE) meant for S-corporations and partnerships was initially flawed due to certain entities being excluded and the resulting California credit being limited to the tentative minimum tax base which in most cases prevented S-corporation shareholders, partnership partners, and LLC members from the intended tax benefit.
The California legislators have expanded the CA PTE tax benefits by addressing these issues which has resulted in the following changes which were recently signed into law:
- Eliminate the tentative minimum tax limitation on the CA PTE.
- Allow tiered partnerships (with the exception of partnership owners) to qualify for the CA PTE.
- Partnership guaranteed payments are now included in qualifying CA PTE electable taxable income.
These changes substantially increase the potential benefit of the election. However, federal law is still uncertain as to the timing of when the tax deduction applies.
Our current understanding and position until clarified by the IRS is that the state tax deduction is a reduction of federal taxable income in the taxable year the payment is paid. For example, a calendar year qualifying entity with $1 million 2021 California qualifying income would need to pay $93,000 elective tax by March 15, 2022 which would result in a 2022 federal reduction of taxable income and a passthrough CA credit of $93,000 that can offset the owners 2021 California income tax. Taxpayers have most likely already paid substantially all of their 2021 California income taxes and the additional $93,000 payment will temporarily reduce cash flow until their 2021 individual California tax return can be filed to refund the overpayment. The resulting federal deduction will be deferred until 2022 delaying the benefit another year.
To further complicate matters California has a June 15, 2022 due date to elect into the 2022 entity tax in which at least 50% of the 2021 elected tax must be paid in to qualify. Therefore even if the qualifying entity has a projected reduction in 2022 California taxable income as compared to 2021, an increased amount must be paid in to qualify for the 2022 election. If the 2021 election was not made the qualifying entity will need to pay in $1,000 by June 15, 2022 to qualify for the 2022 election.
In conclusion the tax benefit has been greatly enhanced and should be considered by all qualifying entities in which we recommend analysis be performed before the March 15, 2022 election deadline to understand the delayed benefit versus the immediate cash outflow needed.
For additional details regarding the CA PTE, please read the previously published article at https://www.cpa-wfy.com/new-law-tax-workaround-for-ca-pass-through-business-owners/.
Please contact your tax advisor at WFY to discuss additional details regarding these tax benefits. Click here to contact a WFY tax advisor.
Wright Ford Young & Co. is headquartered in Irvine, CA and is the largest single office CPA firm in Orange County. WFY is a full service corporate accounting firm offering audit, tax, estate and trust, and business consulting services to closely held company and family business owners. More information about our Firm can be found at www.cpa-wfy.com