The 2017 Tax Cuts and Jobs Act (TCJA) imposed a $10,000 limitation on the deduction of state and local taxes (“SALT”) for federal income tax purposes. In response to this limitation, California adopted the Pass-Through Entity Tax (“PTE”).
How the California Pass-Through Entity Tax Works
If a California entity is taxed as a partnership or S Corporation, the PTE paid to the California Franchise Tax Board by that entity is treated as a business deduction for federal tax purposes at the entity level thereby reducing federal tax liability and is also credited to California individual state taxes. PTE is an elective tax of 9.3% of the entity’s qualified net income. The PTE is allocated to the business owners based on their ownership percentage.
For example, let’s consider an S Corporation with a single owner and qualified net income of $100,000, paying $9,300 in PTE to California. The owner’s federal Schedule K-1 will show $90,700 in ordinary business income. For California tax purposes, the owner reports $100,000 net income ($90,700 federal income + $9,300 PTE) and receives a $9,300 credit on their California personal tax return. In this scenario, the PTE payment would result in approximately $2,100 in federal tax savings for the 2023 tax year if the $100,000 business net income is the taxpayer’s sole source of income and they are married filing jointly.
The PTE payment is made in two installments. The first payment, either $1,000 or 50% of the prior year’s elective tax (whichever is greater), is due on or before June 15th of the taxable year. The second installment, covering the remaining PTE balance, is due on or before the original return’s due date. Failing to make the first installment payment by the due date would render the taxpayer ineligible for the PTE election that tax year.
Due to severe weather storms, the first installment’s due date was extended to October 16, 2023, for residents in many California counties, but not for residents in Lassen and Shasta counties.
Reach out to the professionals at MBA Financial and Accounting Solutions to see how we can help you minimize your tax liability.
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The information contained in this article are current as of this writing and are subject to change.