AB 150 & PTE Breaking Down the Pass-through Entity Tax

Earlier this summer AB 150 was signed into law. This tax budget trailer bill covers various tax related provisions, including language that establishes an elective pass-through entity (PTE) tax.

The PTE tax is intended to provide California taxpayers a method of structuring their state income tax compliance in a manner that provides some relief from the current federal limits on individual state and local tax (SALT) deductions. It applies for taxable years beginning Jan. 1 and before Jan. 1, 2026, which is aligned with the expiration of the current federal rules for state and local tax deductions.

Specifically, the new tax rules allow individual owners of a PTE, such as a partnership or S corp, to shift some of their tax liability to the entity level. This is done by the PTE electing to pay an entity level tax (9.3 percent) to the state and, in turn, provide the individual owners of the PTE a tax credit equal to the owner’s proportional share of the elective tax. The individual owners can then use this credit to offset their state personal income tax liability. At the federal level, the PTE, which is not subject to the federal SALT limits, would deduct the elective PTE state tax from any federal tax liability. In effect, this allows individuals—who are partners, members and shareholders of small businesses structured as a PTE—to deduct SALT beyond the current federal cap. This approach has been accepted by the IRS in Notice 2020-75, which confirmed that the deduction of state PTE taxes are allowable. In the coming weeks and months, the FTB will be working on additional information related to the PTE and the steps that taxpayers will need to take to participate.

This new tax strategy could significantly benefit a number of small business taxpayers, including many CPA firms. The timely advancement of this favorable tax policy is the product of CalCPA’s robust advocacy program and the strong relationship with key policy leaders across the state. CalCPA has worked over the last year to support policies that positively impact the California business climate and allow for the CPA profession to better assist their clients.

To assist CalCPA members in understanding the mechanics, CalCPA is working on developing resources, including an infographic outlining the PTE basics. You can find a virtual version of this here. Keep an eye out for future CalCPA communications about additional resources and learning opportunities for this new tax strategy.

– Updated August 30, 2021