CA’s AB-150 SALT Cap Workaround For Passthrough Entities

On July 16, Governor Gavin Newsom signed California Assembly Bill 150 into law. AB-150 contains tax relief measures that allow certain passthrough entities to pay an elective 9.3% tax of the partners’, members’, or shareholders’ (owners) distributive share of income subject to California income tax. Making this tax election creates an equivalent tax credit on their California individual tax return and an additional deduction on their Federal individual tax return.

Before the 2018 tax year, individual taxpayers could deduct certain State and Local Taxes (SALT) without federal limitations. However, in 2017, Congress passed the Tax Cuts and Jobs Act (TCJA), which imposed a $10,000 cap for state and local taxes. It hit taxpayers living in high-tax states, like California, especially hard as this indirect tax rate increase raised the effective tax rates for some taxpayers to more than 50% between federal and state. California, and several other states, have implemented this SALT workaround using passthrough entities to minimize the impact of the limitation for their residents and taxpayers.

Individuals are limited to deducting $10,000 of SALT on their Federal Individual Tax Return. The new law effectively allows owners to reduce their Federal taxable income via their passthrough entity rather than having an itemized state tax deduction, providing some relief from the current SALT limitation. California’s taxable income within the entity will remain unchanged.

In order to qualify, a passthrough entity makes a timely irrevocable election on an annual basis allowing the entity to deduct the 9.3% elective California tax from the entity’s earnings and remit the payments directly to the Franchise Tax Board on behalf of the owners each quarter. An owner also needs to provide their consent to receive the federal deduction/California tax credit or withhold consent that keeps the status quo on their share of income.

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Although the new law is retroactively effective as of January 1, 2021, there are still many unanswered questions that the CA Franchise Tax Board is working through. We are awaiting further guidance on the full implementation plan from the Franchise Tax Board. If you have additional questions about the SALT cap deductions and AB-150 or your business’ qualification status, please contact your GC accountant, or email us at contactus@gccpas.net.