If you are a high-income earner with a pass-through business entity, the new SALT cap workaround associated with California’s AB 150 Small Business Relief Act may be useful to you this tax season.
In this post, we’ll discuss frequently asked questions about the SALT pass-through workaround and how it could save you thousands of dollars in federal income tax.
What is the SALT cap workaround, aka California Pass-Through Entity Tax?
The SALT cap workaround, resulting from AB 150, allows you to pay pass-through income elective tax at the entity level. This qualifies business owners to avoid the $10,000 federal cap on state and local tax deductions.
The Small Business Relief Act in Assembly Bill 150 is specific to California, but many states adopted similar bills. AB 150 provides a workaround to the $10,000 limit on local and state tax deductions for individuals. The $10,000 limit was established in 2017 with the TCJA (Tax Cuts and Jobs Act).
Before the 2017 Tax Cuts and Jobs Act, individual taxpayers could claim a deduction for certain state and local taxes (SALT) paid in a tax year, if you itemized your expenses. These deductions were unlimited. The Tax Cuts and Jobs Act limited the SALT deduction to $10,000 for individuals and MFJ (married filing jointly), significantly increasing taxpayers’ effective tax rate.
When does California’s SALT pass-through workaround start?
The SALT workaround is an option for the 2021 tax year. It is available through the 2025 tax year.
Who qualifies for the SALT cap workaround?
Partnerships with members as individuals, Trusts, or Corporations qualify for the SALT workaround, as do S-Corps.
Note that for Partnerships, all partners do not have to make the AB 150 election.
How does the Small Business Relief Act work?
If you qualify for the Small Business Relief Act workaround, your pass-through entity could pay your state taxes, reducing the pass-through entity’s net income reported on the owner’s K1 for that year.
Under this rule, you can elect to pay 9.3% of CA state tax through qualified net income.
How is the SALT cap workaround calculated?
Here’s an example calculation of California’s SALT pass-through workaround:
Say an LLC has a qualified net income of $200,000. The Federal Trade Bureau (FTB) payment at 9.3% is $18,600, which means federal income tax box 1 K1 income is $200,000 – $18,600 = $181,400.
If we suppose your federal effective tax rate is 30% by taking this approach, you would pay $5,580.
Note that your state credits using the act are non-refundable but are usable over five years.
Who is not eligible for the Small Business Relief Act?
You cannot use the SALT pass-through workaround if your company is publicly traded, is a C-Corp, if you are Schedule C – Self Employed, or for entities that have a partnership as a partner, member, or shareholder.
How do I utilize the SALT pass-through workaround on my taxes?
You must elect to utilize the SALT workaround when filing your tax return, and the initial payment must be by June 15th of each year you plan to take this election. Election is irrevocable.
Soon you’ll be meeting with your tax professional to file your business taxes, so make sure to discuss SALT with your accountant.
Feel free to contact us with any questions regarding California’s SALT cap workaround!
Photo by Scott Graham on Unsplash
