E3 Coastal Advisors LLP

Finally, some state tax relief…

On July 16, 2021, Governor Newsom signed Assembly Bill 150, which included various different tax relief initiatives. One major change included in the bill for California business owners is the ability to workaround the Federal $10,000 limit on the deduction of state and local income taxes on individual tax returns.

Why this is important

Under the Tax Cuts and Jobs Act of 2018, taxpayers can only deduct a combined total of $10,000 in state and local income taxes on their individual returns. This includes state income taxes, as well as property taxes and other local taxes. Amounts paid over $10,000 were non-deductible for federal tax purposes.

AB 150 will allow passthrough businesses to make certain state tax payments on behalf of its owners and deduct such payments on the business federal return. As a result, this allows the business owner to potentially indirectly deduct state income taxes that were previously non-deductible. Recently, the IRS gave its blessing for this type of arrangement.

How does it work?

For tax years 2021 to 2025, qualified passthrough entities can make a passthrough entity tax payment equal to 9.3% of the passthrough entities net income and deduct such payment for federal tax purposes. 

Qualified passthrough entities generally include S Corporation and Partnerships with certain types of partners. Notably, partnerships with a partnership partner are NOT eligible.

For tax year 2021, the passthrough entity tax must be elected and the 9.3% payment must be made by the original due date of the return WITHOUT extension, which is generally March 15, 2022. 

For tax years 2022 through 2025, a payment is required in two installments:

• The first installment is due on or before June 15th of the taxable year of the annual election, which is to be the greater of either 50% of the elective tax paid the prior taxable year or $1,000.

• The second installment is due on or before the due date of the original return for the qualified entity without regard to any extensions (March 15th for a calendar entity).

 What happens to the tax payments?

The business owner will claim a nonrefundable tax credit on their individual return for any payments made on their behalf. Any unused credit can be carried forward for up to five (5) years.

Who might this benefit?

If you are the business owner of a qualified entity (S Corporation or Partnership) who incurs a State and Local Tax of greater than $10,000 in a year, you may be able to indirectly deduct the state income tax over the $10,000 cap using these payments. Additionally, if your tax bracket is in the 9.3% tax bracket or higher, you may benefit from these payments.

As with any new tax law, there will undoubtedly be some answered questions. But it’s certainly never too late to start planning for the future!