With the passage of the Tax Cuts and Jobs Act (TCJA) in 2017, the state and local tax deduction on Federal personal tax filings was limited to a maximum deduction of $10,000. However, certain taxpayers may be able to claim a larger deduction on their Federal tax returns for their state taxes paid by electing into the “passthrough entity tax” (PTET).
Who Can Make an Election?
In California, qualifying passthrough entities may annually elect to pay an entity level state tax on the income from their pass-through entities (PTET). A pass-through entity is a business where profits and losses flow directly to the owner’s personal tax return instead of being taxed at the entity level. Common examples of pass-through entities include partnerships and S corporations.
The partner/shareholder of the entity must also elect to have their prorated portion of the entity’s income included in this election. The following taxpayers are qualified to make this election for California purposes:
- Individuals, fiduciaries, estates, and trusts subject to California personal income tax
- Disregarded single member LLCs that are owned by individuals, fiduciaries, estates, or trusts subject to California income tax
Please note that various other states have also implemented pass-through entity tax elections, but every state has its own rules and regulations that may differ from the California rules above.
How is the Election Made?
Participants in California’s PTET election must observe strict deadlines. Required payments must be paid by the partnership directly to the California Franchise Tax Board on the following timeline:
- The first payment is due by June 15th of the corresponding tax year, and must be the greater of 50% of the elective tax paid in the prior year or a minimum of $1,000 for those electing the PTET for the first time. It is crucial to make this payment timely, as missing the deadline disqualifies the business from participating in the PTET workaround for that tax year. In order to make the California PTET election for the 2025 tax year, the first 2025 PTET payment must be paid by June 16, 2025.
- A second payment, if necessary, must be made March 15th of the following year. In general, it is recommended that partnerships make their second payment by December 31st to align the Federal tax deduction and California tax credit. This payment represents the remaining pass-through entity tax equal to 9.3% of each taxpayer’s California taxable income of the pass-through entity after considering the June 15th tax payment. For 2025, the second PTET payment must be paid no later than March 16, 2026.
What are the Tax Benefits?
The PTET election allows the pass-through entity to elect to pay the owner’s state tax liability on behalf of the owners. This creates a significant tax advantage because the tax payment becomes a deductible expense at the business level for Federal tax purposes, regardless of the $10,000 personal state and local tax limit on the owner’s personal tax returns. In addition, the PTET paid by the partnership is allowed as a nonrefundable credit for California purposes which gives the owner a credit for the taxes paid on their behalf by the partnership.
For Example:
Jane is the sole member of her S Corporation. For 2025, she estimates that her S Corporation income is $500,000. Jane decides to elect into the PTET option. The S Corporation promptly pays the required amounts by the required deadlines. By participating in the PTET election, Jane receives a Federal tax deduction of $46,500 that would have otherwise been disallowed if she had paid these taxes personally. This saves her approximately $17,000 in Federal tax. For California purposes, Jane receives a tax credit of $46,500 for the amount that her S Corporation paid on her behalf, thus lowering her personal California tax liability.
Ask Realize for Help with PTET Elections
The California passthrough entity tax is complex. We expect it to become more complicated this year as Congress re-evaluates the state and local tax deduction limitation, and whether they will extend the limitation or possibly increase the deduction limit. However, as long as there is a potential limit to the state and local tax deduction, the PTET could be a valuable strategy for taxpayers who own passthrough entities. We are happy to discuss the program with you to determine whether it suits your specific situation.
Talk to Us
We are prepared to strategize. Let us help you reap any benefits still allowed by the latest tax reforms. We can discuss any questions about minimizing taxes and maximizing benefits before the year is over. Contact us today!
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