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Update on State Tax Deduction Limitation Workaround for Owners of Passthrough Entities

By December 10, 2021No Comments
We are writing to update you on the California Passthrough Entity Tax election, commonly referred to as the “AB 150” election. This is an update to our July 23rd eblast.
Background
Federal tax reform in 2017 established a limit, or “SALT cap,” on the amount of state and local taxes that could be deducted by individuals. The SALT cap is currently $10,000 for both single and married filing joint filing statuses, and is scheduled to sunset after the 2025 tax year.
The IRS approved a workaround to the SALT cap in late 2020, and on July 5, 2021, the California legislature passed AB 150. Under AB 150, qualifying PTEs can elect to pay a 9.3% income tax and owners of the entities who pay personal income tax can claim a credit equal to the tax the entities pay. The election is available for the 2021 through 2025 tax years.
Please see our previous AB 150 eblast sent on July 23rd with more information on how to pay the tax, when the tax is due, who is eligible to participate and more details.
AMT Limitation
Subsequent to our original AB 150 eblast, we learned that the Franchise Tax Board has taken the position that the income tax credit taken by a participating owner of a passthrough entity is limited to California tentative minimum tax. In other words, the credit is not allowed for California alternative minimum tax (“AMT”).
Unfortunately, this seriously limits the benefit of AB 150. We have found that some of our clients are still projected to receive an overall benefit by electing AB 150 for their passthrough income, while others are projected to experience an overall tax increase and will not elect AB 150.
The tax benefit (or detriment) that a passthrough entity owner would experience by electing AB 150 is highly dependent on their individual tax circumstances. If you are considering participating in an AB 150 election, we strongly recommend that you consult with your L&B advisor to determine and quantify whether (and by how much) you will benefit by electing AB 150.
Proposed SALT Cap Increase
On November 19, 2021, the House of Representatives passed the Build Back Better Act (H.R. 5376) (the “BBB Act”). Beginning with the tax year 2021, the House version of the BBB Act would raise the cap on the SALT deduction from $10,000 to $80,000 and extend the cap through the 2030 tax year. The BBB Act bill was recently sent to the Senate for its consideration.
If the proposed SALT cap increase becomes law, we anticipate that a passthrough entity owner will still be able to elect AB 150.
Communicating With Your Investors
If you are responsible for filing a partnership or S corporation return and wish to offer your investors the option to participate in an AB 150 election, we recommend you contact them right away to ask if they wish to participate.
When communicating with your investors, matters to consider include but are not limited to:
1. When is the tax payment due? (To secure a 2021 tax benefit for the participating owners, a calendar year passthrough entity must pay the tax by December 31st if it is on the cash basis for tax reporting purposes or March 15th if it is on the accrual basis.)
2. How will the investor notify you if they wish to participate and what is the deadline to notify you?
3. How will the entity source the funds to pay the elective tax? Options include paying the tax from cash on hand and reducing future distributions accordingly to each participating member or requiring that each participating member send a check to the entity for their share of the tax.
If you would like assistance with drafting a communication to your investors regarding AB 150, please contact your L&B Tax Advisor.
Planning for 2022 – Action Needed by June 15th
For the 2022 tax year, a passthrough entity that wishes to make the AB 150 election for one or more of its owners must make a tax payment by June 15th, 2022. The amount of the payment must be the greater of $1,000 or 50% of the elective tax paid in the prior taxable year.
If you have any questions, please reach out to your L&B Tax Advisor.
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