California is one step closer to joining the growing number of states adopting pass-through entity (PTE) tax legislation in response to the 2017 federal tax reform legislation. For federal income tax purposes, the 2017 tax reform limited individuals’ itemized deduction to $10,000 for their separately stated state and local income, sales, and property taxes (SALT).
On July 1, Assembly Bill 150 (A.B. 150), one of the two budget trailer bills that contained California’s iteration of the elective PTE tax language, was passed by the Senate 40-0 and by the Assembly 78-0 and has been presented to Governor Gavin Newsom (D) for final action.
Effectively, California has devised a way to circumvent the federal $10,000 cap on state tax deductions for owners of small business pass-through entities. By making the election on the entity’s 2021 timely-filed tax return, the PTE pays 9.3% California tax on the owners share of the taxable income (in addition to the 1.5% S-Corp tax or LLC tax), and the PTE receives a deduction for the tax paid which reduces the pass-through income reflected on the PTE owners’ Schedule(s) K-1. The tax paid by the PTE is then allowed as a refundable credit to the owners which the owners can claim on their personal California tax returns. If enacted, this provision will expire after the 2026 tax year, or sooner if the federal cap on state tax deductions is repealed.
In addition to the small business relief described above, Assembly Bill 150 also provides for (1) Reenactment and expansion of the Main Street Hiring Credit against income, franchise, or sales and use taxes for the 2021 taxable year. It allows employers with 500 or fewer employees and a 20% decline in gross receipts from 2019 to 2020 to claim a credit of up to $1,000 per net increase in full-time equivalent employees; and (2) A new income and franchise Homeless Person Hiring Credit of between $2,500 per $10,000 per homeless person hired, depending on the amount of hours worked. The credit is available for the 2022 through 2027 taxable years.
We will keep you posted on the progress of this Assembly Bill, which the Governor is expected to sign.
Bruce Strumlauf, Shareholder with LevitZacks, CPAs
