California’s Elective Pass-Through Entity Tax
California enacted an elective pass-through entity (PTE) tax for tax years beginning in 2021 through 2025. In doing so, California joins a number of states that have adopted optional PTE taxes as a workaround to the $10,000 federal cap on deducting state and local taxes. This allows eligible pass-through entities to pay and deduct state taxes at the entity level for federal purposes, while providing a tax credit to the entity owners for state tax purposes.
What entities qualify to make the election?
Generally, an entity qualifies to make the election if it is taxed as a partnership or S corporation and has only the following as partners, shareholders, or members:
- estates; or
Which entities do not qualify?
Having a disregarded entity as a partner, shareholder, or member will not disqualify an entity if the entity meets the other requirements for the election. But, a disregarded entity alone cannot qualify to make the election, because it is not taxed as a partnership or S corporation.
Also, the following entities do not qualify to make the election:
- an entity that has a partnership as a partner, shareholder, or member;
- a publicly traded partnership; and
- an entity permitted or required to be included in a combined report.
How is the election made?
Qualifying entities may make the election annually on an original, timely filed tax return. Once made, the election is irrevocable for that year.
When and how must tax payments be made?
For tax year 2021, the tax is due by the original due date (without regard to extensions) of the entity’s tax return.
For tax years 2022 through 2025, the tax is due in two installments:
- by June 15 of the tax year of the election, at least 50% of the elective tax paid in the prior tax year or $1,000, whichever is greater; and
- by the original due date (without regard to extensions) of the entity’s tax return, the balance of the tax due.
An entity must use Form 3893, Pass-Through Entity Elective Tax Payment Voucher, to make the payments.
If an entity does not make that first payment by June 15, it may not make the election for that tax year.
How is the tax calculated?
The tax is imposed at a rate of 9.3% on the entity’s qualified net income. The tax is in addition to, and not in place of, any other tax or fee that applies to the entity.
For the calculation, the Franchise Tax Board is developing Form FTB 3084, Pass-Through Entity Elective Tax Calculation.
What is qualified net income?
“Qualified net income” is the sum of the pro rata or distributive shares of income subject to California personal income tax of each qualified taxpayer.
Who is a qualified taxpayer?
A “qualified taxpayer” is an individual, fiduciary, estate, or trust subject to California personal income tax that:
- is a partner, shareholder, or member of an electing entity; and
- consents to have their pro rata or distributive share of income subject to tax included in the qualified net income of the electing entity.
It does not include:
- a disregarded business entity or its partners or members;
- a corporation; or
- a partnership.
A partner, shareholder, or member that does not consent to having their share of income included in qualified net income does not prevent an entity from making an election to pay the tax.
How do qualified taxpayers claim tax credit?
Qualified taxpayers may claim a personal income tax credit for their share of the tax paid. The credit is nonrefundable. But, taxpayers may carry over unused credit for up to five years.
Taxpayers must use Form FTB 3804-CR, Pass-Through Entity Elective Tax Credit, to claim the credit.