BY BRYAN D . BLYTHE , CPA

Changes on the Horizon for California Pass-through Entity Elective Tax ?

Over the past several years tax practitioners in California , among other states , have been advising clients on the implications of the pass-through entity elective tax ( PTE ), and how it can be a good option for tax minimization in the right circumstances . However , as is common with new tax laws , there have been some questions and pain points surrounding PTE ’ s implementation .

The California Legislature , with feedback from the FTB , practitioner groups including CalCPA and other interested parties , is considering updates to the PTE-related statutes currently in place .

As a refresher , the California PTE is available for taxable years beginning on or after Jan . 1 , 2021 , and before Jan . 1 , 2026 . This so called “ SALT workaround ” has allowed certain pass-through entities with qualified taxpayers subject to California personal income tax , to pay California income taxes on behalf of participating partners , members or shareholders ( herein referred to as “ partners ”) and in most cases shift the associated federal tax deduction from Schedule A ( Itemized Deductions ) to Schedule E ( Supplemental Income and Loss ).

The participating partners receive a California tax credit ( via CA Schedule K-1 ) for their allocable share of the PTE payments made by the entity .

One significant criticism of the initial PTE legislation is that the stringent June 15 payment requirement causes confusion and frustration to taxpayers who miss or underpay the June 15 payment . Revenue and Taxation Code ( R & TC ) Sect . 19904 clearly requires a mandatory payment “ on or before June 15 during the taxable year of the election , an amount equal to , or greater than , either 50 percent of the elective tax paid the prior taxable year or one thousand dollars ($ 1,000 ), whichever is greater .” If the June 15 deadline is missed or underpaid , then the election is not available for the year under current law .

Overview of Proposed Legislative Changes Senate Bill 1501 , introduced Feb . 16 , 2024 , by California Sen . Steve Glazer ( D-Orinda ), aims to amend various Sections of the R & TC , particularly in regard to PTE and its required June 15 payment date . As of the time of this publication , SB 1501 is being held in suspense by the Senate Appropriations Committee and is not likely to move forward before the end of the year . If passed , the proposed changes to the PTE program are only in effect for tax years 2024 and 2025 .

SB 1501 , as it currently stands in Committee , would make the following noteworthy changes : 1 . Eliminate the mandatory June 15 deadline , meaning if a payment is not made by June 15 , the PTE election could still be made for the calendar year in question .

2 . Impose interest ( to the electing entity ) on the amount of the prepayment that was unpaid or underpaid for the period that begins on June 15 that the prepayment was due and ends on the day of payment . The interest rate employed would be the underpayment rate for noncorporate taxpayers pursuant to IRC Sec . 6621 , currently 8 percent . 3 . Reduce the state tax credit ( to the partner ) when the entity makes a

June 15 payment that is less than the amount due . In the case of an entity that does not make the June 15 payment , the resulting credit would be the typical 9.3 percent credit , reduced by 10 percent . In the case of an entity that makes a June 15 payment that is less than the required amount ( greater of 50 percent prior year or $ 1,000 ), the resulting credit would be the typical 9.3 percent credit , reduced by an amount equal to 10 percent of the amount due but not paid by June 15 .

Examples of How the Proposed Legislative Changes Would Operate Example 1 : June 15th payment less than required Limited partnership “ A ” wishes to elect into PTE for 2024

• 2023 : A elected into PTE for 2023 and that year ’ s total PTE liability was $ 40,000

• 6 / 15 / 2024 payment due : $ 20,000 ( greater of 50 percent of the 2023 PTE amount or $ 1,000 )

• 6 / 15 / 2024 payment actually made : $ 5,000

• Date payment made : Aug . 15 , 2024 ($ 15,000 remaining due )

• Result to entity : A would be charged roughly $ 201 in interest ( 8 percent interest on $ 15,000 , compounded daily for 61 days ).

• Result to partners : As the June 15 amount was underpaid by $ 15,000 , the credit available would be reduced by $ 1,500 ($ 15,000 underpaid amount times 10 percent ).

Example 2 : June 15th payment not made S Corp “ B ” wishes to elect into PTE for 2024

• 2023 : B elected into PTE for 2023 , and that year ’ s total PTE liability was $ 40,000 www . calcpa . org SEPTEMBER 2024 CALIFORNIA CPA 17