There have been recent changes to the passthrough tax laws that we believe would be advantageous to your entity and its members. California has recently ratified AB 150, a credit for passthrough entities, which enables us to credit deductions on both the entity and individual level. Below we have a summary that lists what this credit entails, and how we will go forward in executing.
As this is a very time sensitive issue, we are asking that you read the below and respond whether your entity and its member will be opting in or not no later than March 4, 2022. For the tax years beginning 1/1/21 and ending before 12/31/26, a qualified S-Corporation, partnership, or LLC (taxed as a partnership or S-Corporation) that’s doing business in California and required to file a California return, may make an election to pay a passthrough entity tax on behalf of its members.
This tax is equal to 9.3% of the entity’s qualified California income. This enables the partners, members, and shareholders to take a state tax deduction through the entity previously subjected to the state and local tax (SALT) limitation of $10,000 on their Itemized Deductions. Thus, the payment made at the entity level, is treated as a corresponding state tax deduction on the entity’s federal income in the year paid.
The bottom-line benefit for the partners and shareholders is a federal reduction on their passthrough income in the amount of their passthrough entity tax. This federal deduction should yield a benefit from 20% to 40.8% in cash savings on their individual liabilities. The partners and shareholders also claim their amount of the passthrough entity credit on their Calif individual return which directly reduces their liability.
In order for the partner to qualify to elect in, they must be structured as one following:
– An individual, fiduciary, estate, or trust subject to California personal income tax; or
– A disregarded single member LLC that is owned by an individual, fiduciary, estate, or trust subject to California personal income tax
All partnerships, and S-Corp members will make the election at the entity closest to the ultimate owner. Any entity taxed as a corporation is not eligible for this election.
Who Decides – Managing Partner or Managing Shareholder
As this is an entity election, it is up to the managing partner or shareholder to decide if the entity should utilize cash on behalf of their partners or shareholders who opt in. For partners who do not elect, then a cash equalization may be needed to make everything equitable.
From a cash planning point the managing partner or shareholder could budget this passthrough entity tax in lieu of budgeted cash distributions.
The 1st cash requirement is due 3-15-22 for the 2021 liability. Then, to qualify to make the election for the 2022 tax year, the entity must pay in the greater of $1,000 or 50% of the 3-15-22 payment (or the December 2021 payment if paid in advance).
Managing Partner or Managing Shareholder – Check with investors who wants to make the “election”
If the managing partner or managing shareholder approves the cash outlay for this election, then they need to confirm who wants to participate in the credit opportunity. Again, this is an optional election for the partners and shareholders.
This may be a time-consuming step, so we recommend reaching out to the entity’s partners or shareholders ASAP to ascertain whether each partner or shareholder wants to make the election (see special note on S-Corporations below).
How are Deductions Shared?
The Deduction for partnerships will be specially allocated on the entity’s federal return to match the members who make the election. A California tax credit will be allocated to each partner in the exact amount of their election.
The deduction for S-Corporations will be shared ratably, unless the IRS publishes guidance in this area. Thus, it is probably best that all shareholders elect to have the passthrough tax election apply.
We have attached for your convenience an email ready to go to your members explaining the opportunity and asking for a response.
p.s. Control the direction of your business, let us paint a clear and concise picture of your financial state of affairs. Click here to schedule a free consultation today!