California Expands Pass-Through Entity Tax Benefits

Many of the limitations and drawbacks to paying this tax were removed by SB 113. Now, the passthrough entity elective tax can dramatically reduce the tax liability of many more taxpayers.

If the entity elects to pay the tax at the entity level, this payment is a federal tax deduction, and it reduces the amount of federal K-1 income passed through to the entity’s partners or shareholders.  The entity is not subject to the $10,000 state and local tax (SALT) limitation enacted by the Tax Cuts and Jobs Act, so it can claim a significantly higher tax deduction than an individual can on their individual income tax return. In addition, the individual partners or shareholders will be able to claim up to a 100% credit on their California income tax returns for their share of the tax paid by the entity.

Prior to SB 113, there were significant limitations that made this option unattractive for many taxpayers. However, this new law greatly improved this elective tax option by:

• Eliminating tentative minimum tax limitations
• Including guaranteed payments paid to partners/LLC members in the tax base
• Expanding which entities can make the election and the types of owners for whom the tax may be paid

This may be quite beneficial to many taxpayers, but there are a lot of factors to consider in evaluating whether it makes sense for a pass-through entity to make the election and whether the entity’s partners or shareholders should consent to have the entity pay the tax on their share of the entity’s income.

If you have any questions, please contact us. We are here to help.