December, 2022
California, along with many other states, recently developed a workaround for owners of Partnerships and S-Corps to the $10,000 state and local tax (SALT) ceiling that was included in the 2017 Tax Cuts and Jobs Act. The PTE allows for Partnerships and S-Corporations to pay, to the state of CA, a tax based on 9.3% of the entity’s CA net income. This payment creates a CA tax credit that is passed through to each owner’s respective CA individual tax return. The credit reduces the tax amount owed to CA. The business entity will also deduct this CA state PTE payment from the entity’s Federal income. This lower Federal income is then passed through to the owner’s individual Federal return. This Federal state tax deduction is not limited by $10,000, which is precisely the point of the PTE and why it is is so valuable to utilize.
Example
NOT UTILIZING PTE: ABC Inc., an S-Corp with one 100% owner, John Smith, has $200,000 of net income for year 2022. John does not make any other income for the year. John has a home that he owns and pays $11,000 in property taxes each year. John will owe Federal taxes and CA state taxes on the full $200,000[1]. If John’s effective tax rate is 25% Fed and 9.3% CA, he will owe $50,000 Federally and $18,600 to CA on his personal return. John’s SALT deduction on his Federal return will be limited to $10,000, meaning he is not deducting any of the $18,600 against his Federal income.
UTILIZE PTE: ABC Inc., decides to utilize the PTE and will therefore owe to CA 9.3% of $200,000 directly to CA. ABC, Inc. makes this payment and takes a deduction of the $18,600 against their Federal income, bringing their Federal income down to $181,400[2]. John will pay tax at his 25% effective rate on the $181,400 and not the $200,000. This causes a reduction in his Federal tax from $50,000 to $45,350. John’s CA income is still $200,000 since you cannot claim a CA tax payment as a deduction on your CA return. His total taxes on the $200,000 at 9.3% remains $18,600. As the PTE of $18,600 was paid by ABC Inc., John receives a tax credit of the $18,600 against his $18,600 of tax, bringing his balance down to zero on his personal CA tax return. So by utilizing the PTE, John has saved $4,650 in Federal taxes. He owed the same $18,600 to CA, but rather than paying it personally, it was paid by ABC Inc.
Requirements
The PTE requires that an electing entity must pay the greater of 50% of their prior year PTE total, or $1,000 by June 15th. So if this is the first year claiming the PTE, a $1,000 payment must be made by June 15th. If not your first year, you need to pay 50% of the prior year PTE total. The remaining balance due must be paid by the due date of the Partnership or S-Corp return, March 15th. This does not include extensions. IMPORTANT: the June 15th deadline is a strict deadline and if not adhered to, the PTE will not be available to you for that year.
Planning Opportunities and Recommendations
The PTE is very valuable and as such, Rohr CPAs will provide the necessary vouchers and instructions to make the appropriate payments. In addition, as part of our annual end of year tax planning we will help calculate the estimated remaining PTE and calculate the benefit of making the payment by December 31st, allowing for the full PTE deduction in the current year. Please see note 2 below regarding this.
[1] For simplification purposes. In reality John will have either the standard deduction or itemized deductions to deduct against the $200,000 in income along with the Qualified Business Income deduction. The PTE still operates to reduce the Federal income and therefore a full in depth example is beyond the scope of this article.
[2] A current year deduction requires that the PTE be paid during the year. To get a current year benefit the second part of the PTE payment that is due March 15th should be paid by December 31 of the current year.