On February 9, 2022, California Governor Newsom signed Senate Bill No. 113 into law. While this California bill includes various provisions, some of the changes will have an immediate impact regarding the pass-through entity tax (PTET), which was created as a workaround to the SALT deduction limitation.
Highlights of the California pass-through entity tax provisions are as follows:
Provisions that are retroactive to January 1, 2021:
- One of the more onerous provisions limited the California PTET credit to the amount of the CA tentative minimum tax. Effectively, the PTET credit could not be utilized to reduce CA regular income tax below the amount of the tentative minimum tax. This provision has been repealed and may allow more of the credit to be used each year.
- In the original legislation, a partnership that had another partnership as a partner, was not a qualifying entity and therefore could not make the PTET election. Under the new provisions, a qualified entity can now include a partnership as an eligible partner, shareholder, or member for purposes of the definition of a qualified entity.
- A single-member LLC would now qualify as a partner eligible for the pass-through entity tax, depending on the beneficial owner of the single-member entity. (However, the single-member entity itself is not a “qualified entity” for purposes of making the PTET election.)
The following provisions will be effective for tax years beginning January 1, 2022:
- The bill changes the rules relating to the ordering of claiming the PTET credit. Under the revised provisions, the PTET credit will reduce the California tax after claiming the credit for taxes paid to other jurisdictions. This should be a taxpayer-friendly provision as any unused PTET credit is allowable as a carryover.
- Existing law suspends the provisions of the deduction for a net operating loss for tax years beginning on or after January 1, 2020 and before January 1, 2023. This provision reinstates the net operating loss provision a year earlier, for tax years beginning on or after January 1, 2022.
- Existing law limits the amount of various credits allowable against the personal income tax to $5 million for taxable years on or after January 1, 2020, and before January 1, 2023. The bill removed the credit limitation one year earlier by removing the limitation for tax years beginning on or after January 1, 2022.
If you have any questions on how these California pass-through entity tax changes impact you and your entities, please contact your Untracht Early advisor.