In December 2017, the Tax Cuts and Jobs Act (TCJA) became law, representing the most significant federal tax code overhaul in the United States in more than three decades. In part, the TCJA limited the state and local tax (SALT) deduction on federal tax returns to $10,000. In response, several states have enacted an elective pass-through entity tax as a workaround.

On July 16, 2021, California joined the group when its governor signed into law California Assembly Bill 150 (AB 150).

How California Assembly Bill 150 Works

A pass-through entity (PTE), which is also known as a flow-through entity or fiscally transparent entity, is a legal business structure wherein income flows through to the business entity’s owners and investors, rendering the income of the entity as the income of the owners or investors.

Here’s how California’s elective pass-through entity (PTE) tax works:

1. A qualifying elective PTE pays 9.3 percent of qualified net income — the taxpayer’s share of income (including interest, dividends, and capital gains) from the PTE — to the California Franchise Tax Board (FTB).
2. At year’s end, the PTE issues a federal K1 showing the taxpayer’s income from the PTE as 9.3 percent less than what the taxpayer received. This lowers the taxpayer’s federally reported income from the PTE by 9.3 percent.
3. The taxpayer claims a credit on his or her state tax return equal to the PTE tax paid to the FTB.

Note: The pass-through entity tax reduces only the federally reported income, not state reported income. The PTE files a separate state K1 reporting 100 percent of what it paid the owner.

Here’s an example: Continue reading… Continue reading… Continue reading…