California just enacted Senate Bill 113 (SB 113), which made California’s new passthrough entity elective tax much more attractive for certain owners of S corporations, partnerships, and LLCs taxed as a partnership or S corporation.
Many of the limitations and drawbacks to paying this tax were just recently removed by SB 113. Now, this passthrough entity elective tax can dramatically reduce the tax liability of many more taxpayers.
This is because if the entity elects to pay the tax at the entity level it reduces the amount of federal K-1 income passed through to you. 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 you can on your individual tax return. Plus, you get to claim up to a 100% credit on your California return for your 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; and
- Expanding which entities can make the election and the types of owners for whom the tax may be paid.
If you are a shareholder, partner or member of an S corporation, partnership, or LLC taxed as a partnership or S corporation, you might be able to significantly reduce your tax liability as a result of this greatly expanded SALT workaround.
This may be quite beneficial, 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 you should consent to have the entity pay tax on your share of the entity’s income.
If your entity has not already planned to make this election or if you have not previously opted in as an individual owner of the qualified entity, please contact us as soon as possible so we can discuss whether California’s passthrough entity tax will benefit you.