What are the effective dates of the pass-through entity tax (PTET)?
The elective pass-through entity tax (PTET) is effective for tax years beginning 1/1/2021 and before 1/1/2026. The California PTET will terminate prior to 1/1/2026 upon termination of the current federal $10,000 limitation rule, should that occur.
What is the basis of the tax?
The tax is on “qualified net income” will be paid on all income reported on the K-1 including interest, dividends, and capital gains. This only includes the income from all consenting partners, members or shareholders. This includes guaranteed payments (reported on the K-1) subject to California personal income tax.
Are items of income such as proceeds from an asset sale included?
Typically, if an entity is sold in an asset sale, then the gain from that asset sale (an entity-level asset) would be entity-level income which would be subject to the tax. However, sale of stock or ownership interests would typically generate owner-level income, and that income is not subject to the tax. The California Franchise Tax Board (FTB) has clarified that where a qualified taxpayer sells its interest in a qualified entity, the gain from the sale is NOT included in the qualified entity’s qualified net income calculation.
What entities are considered qualified entities for purposes of making the election?
Entities taxed as a partnership or S Corporation
What members of a pass-through entity are considered “qualified taxpayers” for purposes of allowing the pass-through entity to make the election?
A qualified taxpayer is a partner, member, or shareholder of an electing qualified entity that is:
- An individual, fiduciary, estate, or trust subject to California personal income tax.
- A disregarded single member LLC that is owned by an individual, fiduciary, estate, or trust subject to California personal income tax.
- The FTB has confirmed that a living trust whose income is reported on the grantor’s return is considered a taxpayer under California statute §17004 and does not disqualify an entity from making the election.
- Previously, entities with partnerships as members or shareholders were disqualified from making the election, but that limitation has been removed.
When must the PTET tax be paid?
The tax must be paid by the original due date of the entity’s return.
The entity has until the extended due date of the return to make the election. This means entities must estimate their liability by the due date of the return and pay that amount. The owners’ credits will be limited to the amount paid in by this date.
Must all qualifying partners / members make the election for the pass-through entity to pay the tax on their behalf?
No. Each qualifying taxpayer may separately elect to be subject to the tax. If qualifying taxpayers choose not to make the election, other eligible partners / members may still make the election.
Is the PTET tax rate bracketed or a flat rate?
The PTET tax is calculated on the qualified net income of the entity making the election, computed at a flat rate of 9.3%.
Is the calculation different for California and non-California partners / members?
Yes. For California taxpayers, this would include all distributive income from the pass-through entity. For nonresident taxpayers, this would include only California-source income.
When must a qualified entity make the election?
A qualified entity makes the election on its original, timely filed return, and the election is irrevocable.
Does an “original, timely filed” return, include returns filed on extension?
Yes. The election may be made on an extended return (assuming the extended return is timely). Note that payment of the tax must still be made by the original due date, not the extended due date.
Must electing taxpayers (pass-through entities) make an estimated payment or payments during the tax year?
Yes, for tax years beginning after 1/1/2022 and before 1/1/2026. Note that for tax years beginning on or after 1/1/2021 and before 1/1/2022 – one (1) payment is required (the elective PTET tax is due and payable on or before the filing due date of the original return (regardless of extension)). For example, this would be March 15 for calendar year taxpayers.
For tax years beginning on or after 1/1/2022 and before 1/1/2026, two payments are required: for calendar year taxpayers, 50% of the PTET tax paid in the prior year or $1,000 (whichever is greater) must be paid by June 15. For a calendar year taxpayer, the second payment (balance of tax due), is due on or before the original due date of the return (March 15).
Are there any exceptions to making the mid-year prepayment?
No. Under the PTET legislation, no reasonable cause exception, or other exception was provided. It is also important to note that if a mid-year prepayment is made timely, but only later discovered that the prepayment did not meet the 50% requirement, the entity will lose its eligibility to make the election.
Are there any exceptions to penalties imposed on S Corps required to make their PTET payment electronically (via EFT) who process payment via check?
Yes. Under current FTB guidance, the FTB will review each instance on a case-by-case basis to determine if there was reasonable cause for the failure to file the PTET payment electronically.
Does the same prepayment requirement apply to entities formed after June 15 of a calendar year (for a calendar year taxpayer)?
No. Entities whose taxable year does not include June 15 in its short period taxable year are not subject to the prepayment requirement for that taxable year.
For partners / members that elect to have the pass-through entity pay the 9.3% tax on their behalf, does that satisfy the partners’ / members’ California tax liability?
No. The PTET tax is in addition to any other required personal or corporate income tax. For example, for an individual, if a partner in a partnership is subject to a California personal income tax bracket greater than 9.3% and elects to have the partnership pay 9.3% on her distributive share, she will also owe tax on the amount not subject to the partnership’s 9.3% payment.
Does the PTET election affect nonresident partner withholding (the 7% withholding requirement)?
No. The PTET election does not affect the 7% withholding requirement. In other words, if the entity withholds 7% from a nonresident partner, that 7% is not treated as a credit against the flat 9.3% PTET tax.
California allows partners / members to take a credit on their California return for the tax paid on their behalf by the pass-through entity. What if the allowable credit exceeds the taxpayer’s net tax due?
Where the allowable credit for a taxpayer exceeds the taxpayer’s net tax due, the (nonrefundable) excess credit is allowed as a carryforward to the following 5 years.
If a consenting qualified taxpayer happens to be an estate or trust, does the credit flow through to the beneficiaries?
Yes – estates and trusts can pass credits through to beneficiaries. This includes grantor trusts.
If a qualified entity files a nonresident group return, can it also take the PTET credit and claim it on the group return?
No. The partnership may file a group return, but the PTET credit cannot be claimed on a group return. The PTET credit is only available on individual returns of qualified taxpayers.
What current forms can taxpayers use?
To make the tax year 2022 PTET elective tax payments and calculate the 2022 PTET elective tax and for qualified taxpayers to claim the 2022 PTET elective tax credit:
- 2022 Pass-Through Entity Elective Tax Payment Voucher (FTB 3893)
- 2022 Pass-Through Entity Elective Tax Calculation (FTB 3804
- 2022 Pass-Through Entity Elective Tax Credit (FTB 3804-CR)
Qualified entities can use the following tax form to make the tax year 2023 PTET elective tax payments:
- 2023 Pass-Through Entity Elective Tax Payment Voucher (FTB 3893)
Has the FTB provided guidance for taxpayers making third and / or fourth quarter estimated tax payments?
Yes. According to the FTB:
- The newly enacted credit is R&TC §17052.10, is included in Part 10 and therefore it is one of the credits that reduce the computation of estimated payments.
- This means that those taxpayers eligible to claim the credit may reduce their third and/or fourth quarter estimated tax payment to account for additional amounts that will be paid in through the new PTET.
Are prepayments of the credit amount considered estimated tax payments?
No. Qualified taxpayers reduce the amount of their overall tax due by the amount of Passthrough Entity Tax Credit that they claim for purposes of determining any underpayment of estimated tax penalties. (R&TC §19136(c)(2)). However, prepayments of the credit amount are not considered estimated tax payments.
When projecting third and fourth quarter estimated tax payments, practitioners should not consider the credit amount as an estimated tax payment. Instead, they would reduce projected tax liability by the credit amount and use that reduced amount to calculate third and fourth quarter estimate payments.
What if the qualified entity overpaid its PTET tax?
- The overpaid amount cannot be carried forward and designated specifically to the entity’s following year’s mid-year PTET prepayment requirement.
- The overpayment can be applied to other tax liabilities, or
- Refunded to the entity when it files its return.
What is the current treatment of the PTET Credit in relation to the Alternative Minimum Tax (AMT)?
Under current guidance, the PTET Credit can reduce a taxpayer’s Tentative Minimum Tax for tax years beginning on or after January 1, 2021. Under previous guidance this was not allowed, which limited the benefits of taxpayers subject to the alternative minimum tax (AMT).
What is the current treatment of the PTET Credit in relation to the Other State Tax Credit (OSTC)?
Under current rules, taxpayers eligible for both the PTET Credit and OSTC first apply the OSTC, the apply the PTET Credit, to maximize the benefit of both credits. Prior to a more recent law change (Senate Bill 113, updated by Senate Bill 851), taxpayers had to use the PTET Credit prior to the OSTC (potentially reducing the taxpayer’s California liability to zero before the OSTC could be utilized). Senate Bill 851 requires the PTET credits to be included in the owner’s California tax liability (by increasing the “net tax payable” by the PTET credit that reduced the tax), ensuring that owners of entities electing the PTET can claim the same amount of OSTC as they had if the entity had not elected the PTET.
What can single-member LLC (SMLLCs) do to become qualified to make the election to pay the PTET tax?
Per FTB (8/31/2021): A single member (SMLLC) cannot make the election to pay the passthrough entity tax. To be eligible, they must add a member or elect to be treated as an S corporation. However, an SMLLC owned by spouses can elect to be taxed as a partnership and can qualify to pay the passthrough entity tax. (Rev. Proc. 2002-69)
Can the PTET election be made on a superseding or amended return?
If the taxpayer’s return meets the requirements of a superseding return, the PTET election can be made on that return. If the taxpayer’s return does not meet the requirements of a superseding return and is only considered an amended return, the PTET election cannot be made on that amended return.
Per current FTB guidance: A return can be a superseding return only if either (1) the first return and the superseding return(s) were filed before the original due date or (2) the original return and superseding return(s) were filed on extension. If a return is a superseding return, the PTET election can be made or revoked on that superseding return. The superseded return(s) in (1) and (2) (above) are treated as the original timely filed return.
- Cannot elect: Taxpayer files on the original due date and then files a return after the original due date and before the extended due date. Taxpayer cannot make a PTET election on the second return because it is not a superseding return. The second return is an amended return.
- Can elect: Taxpayer files after the original due date and then files a second return before the extended due date. Taxpayer can make a PTET election on the second return because it is a superseding return and treated as an original timely filed return.
Superseding Return Examples (FTB)
- On May 1, 2022, taxpayer-partnership, a calendar year taxpayer, filed an original return and did not make a PTETT election. On September 10, 2022, taxpayer-partnership filed an amended return and made a PTET election. The amended return is a superseding return because both returns were filed after the original due date of March 15, 2022, and before the October 15, 2022, extended due date. The PTET election is valid.
- On February 10, 2022, taxpayer-partnership, a calendar year taxpayer, filed an original return and did not make a PTET election. On March 15, 2022, taxpayer-partnership filed an amended return and made a PTET election. The amended return is a superseding return because the original return was filed on or before the original due date of March 15, 2022, and the amended return was filed on the original due date of the return. The PTET election is valid.
- On March 10, 2022, taxpayer-partnership, a calendar year taxpayer, filed an original return and did not make a PTET election. On September 10, 2022, taxpayer-partnership filed an amended return and made a PTET election. The amended return is not a superseding return because the original return was filed prior to the original due date of March 15, 2022, and the amended return was filed after the original due date of March 15, 2022, even though the amended return was filed within the extended due date. The PTET election is NOT valid.