California's PTE elective tax: what S-corp and partnership owners should know
The pass-through entity elective tax is one of the most valuable federal deductions available to California business owners — and one of the easiest to forget.
When the Tax Cuts and Jobs Act capped the state and local tax deduction at $10,000, California — along with most other states — responded with a workaround: the pass-through entity (PTE) elective tax. For eligible S-corps and partnerships, the entity pays California tax on behalf of its owners, deducts it as a business expense on the federal return, and the owners receive a dollar-for-dollar credit on their California 540.
The mechanics are straightforward. The election is annual and must be made on a timely-filed return. The payment is due in two parts: a prepayment by June 15 of the tax year, and the balance by the original return due date. Miss the June 15 prepayment by even a day and the entire election is void for that year.
Not every owner benefits. Owners who don't itemize at the federal level, or who live in a state without an income tax, generally don't. But for most California business owners in the top bracket, the election is worth several thousand dollars per $100,000 of pass-through income — often more.
The interaction with the owner's personal return is where this goes wrong most often. The credit has to be claimed on the 540, basis has to be tracked, and the AMT interaction has to be considered. We walk through this with every eligible client during the June planning meeting.