By: Bruce J Legawiec, CPA/Partner, Osborne Rincon CPAs
As many taxpayers know, the IRS limits the deduction for personal taxes on Schedule A to $10,000. This is known as the SALT limit. In a high-income state like California, this has resulted in the loss of a deduction and an increase in federal tax.
However, there is good news with the recent passage of AB 150 for members of pass-thru entities, such as S corporations, LLC’s and partnerships. AB 150 created a work-around for the current $10,000 SALT limit. This bill permits an elective tax that allows taxes related to the pass-thru income to be paid at the entity level. This means owners will be able to bypass the SALT cap limit.
Qualified owners must consent to the entity making the election to pay the elective tax. The rate of the tax to be paid is 9.3% of the owner’s share of net income. Not all owners need to make the election. The benefit of making the election is that the tax paid reduces the federal K-1 taxable income, and the amount of tax paid is a credit on the personal state tax return to offset state income tax. The credit is a nonrefundable credit against California income tax. If the credit exceeds the tax liability, the excess credit can be carried forward for up to five years.
The FTB will be issuing more guidance as to the method of election and forms to file to make the payment of tax. For federal income tax purposes, there will only be a reduction of 2021 K-1 income if the payment of tax is made before the end of 2021. This means that prior to year-end, the entity will have to estimate pass-thru income and each member will have to determine their share of allocated income – then notify the entity to make the tax payment on their behalf. Note: the amount of payment that is permitted is 9.3% of the allocated K-1 income.
Actions that should be considered at this time include: 1) Determine projected pass-thru income for 2021; 2) If an election will be made, it may be possible to reduce other tax payments to the state by Form 540-es or withholding of state taxes through wages; and 3) Prepare 2021 tax projections to determine if AB 150 will be of benefit to you.
As noted, the FTB will be issuing more information as to the method to make the election and forms for the payment of the tax. AB 150 has the potential to be very beneficial to owners of pass-thru entities when the right course of action is followed.
If you need a tax advisor to ensure you are informed on all the latest tax requirements, please contact Osborne Rincon at (760) 777-9805.