Proposed Changes for the California Passthrough Entity Tax Credit

The benefits of the state passthrough entity tax credit (PTET) have been in full swing since 2021.  To date, 36 states have implemented a way for certain taxpayers to take advantage of this credit, all of which have their own rules on how to passthrough entity owners can benefit.  

California has a unique rule that hindered some entities from being able to take advantage of PTET, but soon this rule may be changed to the benefit of the taxpayer. 

As a recap, the Tax Cuts and Jobs act of 2017 capped the state and local (SALT) deduction to $10,000 annually. This rule is in effect for tax years 2018-2025. Subsequent legislature aimed to repeal or change the SALT limitation ultimately failed to make its way into law.  

High income tax states began to explore workarounds such as making donations to certain charitable organizations and receiving state tax credits for the amount of the donation. Unfortunately, the IRS publicly announced those workarounds would not be permitted.  

Relief finally came in November 2020 under IRS Notice 2020-75 stating specified income tax payments would be allowed as federal tax deductions that are made on passthrough entity returns. These state tax payments made by a partnership or s-corporation are deductible at the entity level. In addition, those tax payments are reported as income tax credits on the owner’s state tax returns.  

Understanding California’s Passthrough Entity Tax Credit  

California’s rules are unique in that an entity must make a payment to the Franchise Tax Board by June 15th of the current tax year to be allowed to elect into PTET for that tax year. The payment due is the greater of $1,000 or ½ of the total California PTET reported on the prior year’s Form 3804. If the payment is not made timely or an entity estimated less than half of the prior year PTET, the election for the current year PTET is lost and no relief will be granted.  

A bill in California’s state legislator was introduced in April 2024 that would provide much needed relief. If passed, passthrough entities would be able to make the PTET election even if no payment is made by June 15th. Payments are still due on June 15th and if a timely payment is not made, a 5% penalty plus interest would be imposed.  

The change would be effective for tax years beginning January 1, 2024. Check back for updates on this legislation.