On February 9, 2022, Governor Newsom signed SB 113 that, in part, expanded the state and local tax (SALT) workaround law enacted under AB 150. The pass-through entity (PTE) elective tax paid for its consenting owners is deductible for federal purposes, and not subject to the annual $10,000 SALT limitation established by the Tax Cuts and Jobs Act in 2017. The IRS approved the SALT workaround with the issuance of Notice 2020-75. These consenting owners also receive California tax credits for their share of PTE taxes paid. Please note that calendar-year businesses must act by March 15, 2022, to take advantage of the PTE elective tax for 2021.
Prior to SB 113, the credits relating to the PTE elective tax did not reduce the California income tax below the tentative minimum tax, and any unused credits are carried forward up to 5 years. SB 113 removed the tentative minimum tax limitation and made other taxpayer-favorable changes listed below. Except for item (e), all other changes will apply retroactively to 2021 tax liabilities:
a. PTE credits reduce net tax below a taxpayer's tentative minimum tax
b. Qualified PTE can have owners that are partnerships
c. Qualified taxpayer includes certain single-member LLCs
d. Qualified net income includes guaranteed payments
e. Other State Tax Credits (OSTC) will be used before the PTE tax credits, effective beginning 2022
For owners of PTEs with multi-state operations, attention must be paid to the credit ordering rules to utilize the PTE tax credit. The other state tax credits (OSTC) for these taxpayers may be greatly reduced in 2021 because the PTE tax credits are applied first. SB 113 has addressed this credit ordering issue and will require the OSTC to be used before PTE tax credits, but only for taxable years beginning on or after January 1, 2022.
To be eligible for the PTE election for taxable year 2022, PTEs must make a prepayment by June 15, 2022, of an amount equal to the greater of 50% of the 2021 elective tax paid or $1,000. Early tax projections will clarify the tax benefits and cash flow requirements related to the 2022 PTE elective tax payments.
The IRS has not issued proposed regulations, and state PTE regimes vary, both adding to compliance issues. At BPM, we understand the challenges that come with the ever-changing tax landscape and we continue to stay abreast of the developments in this dynamic area of SALT workarounds. Please reach out to your BPM tax advisor to discuss the potential opportunities related to the PTE tax election.