California has passed legislation to allow owners of pass though entities such as partnerships and S-Corporations to bypass the state and local tax (SALT) cap of $10,000 for individuals. For taxable years beginning on or after January 1, 2021, and before January 1, 2026, California law allows an entity taxed as a partnership or an “S” corporation to annually elect to pay an elective tax at a rate of 9.3 percent based on its qualified net income. The election shall be made on an original, timely filed return and is irrevocable for the taxable year.
State and Local Tax Deduction Limited to $10,000
Taxes paid to the State and county, weather income tax or property tax, can only be deducted up to $10,000 on your individual Federal tax return under current federal law. Therefore, instead of deducting the amount of tax paid to the state of California on your personal return where it is limited, your business entity will pay your state taxes on your behalf; moreover, your business entity has no limit on its deduction for state taxes paid. You will then transfer the credit for the taxes paid to your individual tax return, like a gift certificate. Your business entity income will then be lower, as well as your personal tax liability.
Steps to claim the Elective Tax Payment
There are still several limitations on the procedure. The biggest of which is of course that you must own a partnership, S-corporation, or a LLC that has elected to be taxed as either of the above. Next, all the owners of the entity must consent to this new program (but only most need to participate), so in large entities with many owners it is not likely to work, but it is ideal for smaller businesses.
The next limitation is that the tax can only be up to 9.3 percent of the profit coming out of the entity, so it is tied to the income produced by that entity specifically. That means this is good for someone who owns a s-corp and makes all of their money though it, but it’s not very useful to someone who has a day job and just has a LLC they make a bit of money on the side with.
Another limitation is if your entity is a partnership that owns another entity, the owned entity cannot do this trick for the partnership. If there are any non qualified owners, the rule is not allowed.
For S-corporations where compensation is paid by a mix of W2 income and profit distributions, this benefit is reduced by the fact that it only applies to the profit from after you pay the wages.
In other words if there is not a profit in your entity after paying your required w2 compensation, this will not help you.
Finally, if you make payments in excess of the 9.3% max, it is applied to your personal tax return, and the FTB will not refund it. The excess payments will be instead passed on to the next year as a carryover. This might make tax planning a bit more tricky.
June 15th Deadline for Elective Tax Payment: How Much?
The elective tax payment law allows a credit against the personal income tax to a taxpayer, other than a partnership, that is a partner, shareholder, or member of a qualified entity that elects to pay the elective tax; moreover, the maximum amount is equal to 9.3 percent of the partner’s, shareholder’s, or member’s pro rata share or distributive share and guaranteed payments of qualified net income subject to the election made by the qualified entity.
BEFORE JUNE 15TH you must use the payment voucher Form 3893 to make the payment. The first payment must be either $1,000, or 50% of last year’s total payments, whichever is greater.
You can file it electronically on the FTB business website (no form needed) https://www.ftb.ca.gov/pay/index.html (select business, then webpay business)
Print the voucher here: https://www.ftb.ca.gov/forms/2022/2022-3893.pdf
And Mail it with your payment to:
Franchise Tax Board
PO Box 942857
Sacramento, CA 94257-0531
You may make other payments during the year at your discretion, but you must make the final payment by March 15th of the following year. Contact Disparte Tax Law today. You may want to refer to our state and local tax deduction guide.