Updated: February 9, 2023

This article has been updated to include California Senate Bill 113 which made the following changes for “tax years beginning on or after January 1, 2021” per FTB notice

• • The Pass-through Entity Tax Credit can reduce the amount of tax due below the tentative minimum tax.
  • Qualified net income includes a qualified taxpayers’ guaranteed payments received from the qualified entity subject to California personal income tax.
  • A qualified entity can have a partnership as a direct owner.
  • A qualified taxpayer who is a partner, member, or shareholder of a qualified entity can be a disregarded single member limited liability company (SMLLC), as long as the disregarded SMLLC is solely owned by an individual, fiduciary, estate, or trust subject to California personal income tax.
  • Additionally, for taxable years beginning on or after January 1, 2022, the Pass-through Entity Tax Credit should be applied after the other state tax credit.

What is California AB 150?

Before 2018, those Americans who itemized their federal income deductions were allowed to deduct – in some cases fully – their state and local income taxes, also known as SALT. The SALT deduction was a major tax benefit for individual taxpayers in high-income and high property-states like California.

Then in December 2017 The Tax Cuts and Jobs Act (TCJA) capped the SALT deduction at $10,000, thereby limiting a taxpayer’s itemized deductions and tax benefits.

In response to the SALT cap, a number of states like New York, New Jersey, and Connecticut created workarounds to assist their taxpayers hurt by the cap. Similarly, the IRS issued Notice 2020-75, which allows for partnership and S-corporation SALT to flow through to the individual as a deduction.

What is the Small Business Relief Act under California AB 150?

Part 10.4 of the California Assembly Bill No. 150 (AB 150), passed on July 16, 2021, is California’s answer to the SALT-cap deduction.

Note that only the Small Business Relief Act (Part 10.4) of AB 150 addresses the SALT workaround. The other sections of AB 150 are not covered in this article and include permanently extending the sales tax exclusion on the sale of diapers and menstrual hygiene productions; extending a 15% credit on the donation of fresh fruits and vegetables to a food bank; small business hiring credit, and increasing the CalCompetes tax credit.

The Small Business Relief Act (“Act”) is the heart of AB 150 that impacts the majority of California residents, especially pass-through entity business owners. Under the Act, eligible taxpayers may choose to pay an elective 9.3% tax on their net income and then claim a nonrefundable credit on their personal tax returns. 

Since only pass-through entities qualify, the additional elective tax essentially lowers the net profit that is passed through to each shareholder or partner on their K-1, thereby reducing their personal-tax liability. 

AB 150 will repeal when the SALT limitation of the TCJA expires or the Act will become invalid if the federal SALT limitation is repealed, on or before December 1, 2026.

Which Entities Qualify for the Small Business Relief Act under AB 150?

To qualify for the Small Business Relief Act under AB 150, the entity must be either a partnership (file IRS Form 1065) or an S-Corporation (file IRS Form 1120S). Owners of such pass-through entities can include: individuals, trusts, estates, and corporations subject to personal-income tax. 

Which Entities Do Not Qualify for the Small Business Relief Act under AB 150?

The following entities do not qualify: publicly-traded partnerships; C-Corporations; “an entity that is permitted or required to be in a combined reporting group”; and, unfortunately, self-employed individuals who file Schedule C (see below). 

How to Calculate the Benefit of AB 150

Currently, California pass-through entities are subject to either a 1.5% tax on their net income or a minimum franchise fee, depending on their entity type. 

According to the Act, the elective tax would be “in addition to, and not in place of, any other tax or fee required to be paid” by the entity.

For example, let’s assume an S-Corporation with a single shareholder has a net income of $350,000. Without the AB 150 election, the S-Corporation would owe $5,250 (1.5% of $350,000) in California franchise tax, and the single shareholder would receive a K-1 reporting $350,000 of pass-through income on which he would have to pay income taxes. 

AB 150 does not give details on the calculation, but based on our interpretation of the Act, the same S-Corporation shareholder who made the election would pay an additional 9.3% or $32,550 in taxes plus the 1.5% or $5,250 for a total of $37,800. The shareholder would then claim a $32,550 credit on their personal tax return to claim a refund of the amount paid. If the credit is greater than the net tax owed by the individual, the credit is carried forward to the “following taxable year and succeeding five taxable years, if necessary, until the credit has been exhausted.” See example here.

When are Taxes Due for AB 150?

For the 2021 tax year, the tax is due by the filing deadline, “without regard to any extension of time for filing the return.” 

For example, for a calendar-year entity, the deadline to pay 2021 taxes would be March 15, 2022. Beginning in 2022, the tax will be paid in two installments:

• 50% of the tax or $1,000, whichever is greater, is due by June 15th of the taxable year; and 
• The second installment is due by the tax filing deadline, again without regard to any extensions.

If no payment is made as required, then the entity may not make the election to pay the elective tax.

Key Takeaways from the Small Business Relief Act of AB 150

• Not all shareholders or partners have to consent to the election.
• Each shareholder or partner must make the election individually.
• The election must be made annually by the original tax filing date.
• The election cannot be made on an extended tax return.
• The election is irrevocable for the year of the election.

What are the downsides to AB 150?

• It does not benefit individuals who earn W-2 wages.
• It only applies to pass-through entities.
• It appears that Single Member LLCs would not qualify because they are considered a disregarded entity with the IRS and have no federal income tax or filing requirements.
• It does not benefit individuals who are self-employed and file Schedule C. May encourage self-employed people to incorporate. 
• There is no benefit if the corporation or partnership is reporting a loss.
• The elective tax lowers the pass-through entity’s benefit from the federal Qualified Business Income, a generous deduction granted under the TCJA.
• The Act as currently written is unclear what happens to the unused credits if the TCJA or the Small Business Relief Act is repealed. 

Originally, the PTE credit did not offset a person’s California Tentative Minimum Tax (TMT). However, California Senate Bill 113  passed on February 7, 2022 now allows the PTE tax credit to reduce the amount of tax due below the TMT. 

Looking for an independent fiduciary financial advisor who can advise you on investments, retirement, real estate, alternative assets, and taxes? Contact ACap Advisors & Accountants to schedule a free initial consultation. Our clients include individuals, small businesses, entrepreneurs, and anyone serious about saving and investing for their future.