In 2017 Congress capped the amount of state and local taxes individuals could deduct at $10,000. In July 2021, California enacted the Small Business Relief Act (“SBRA”), which allows S-Corporations, partnerships, and some LLCs (pass-through entities or” PTEs”) to elect to be taxed at the entity level for state taxes in exchange for a state income tax credit for the owner. The goal is to make the California income tax paid by the PTE a deductible business expense and give the owner an income tax credit reducing the amount of state income tax they pay and report to the federal government.
The SBRA[1] provides that for the taxable years beginning January 1, 2021 through the taxable year ending December 31, 2025, select PTEs may elect to annually pay an entity-level tax of up to 9.3% of the state taxable income of the partners, shareholders, or members. The partners, shareholders, and/or members then receive an equivalent tax credit on their individual state tax return.
The PTE must be taxed as a partnership or “S” corporation. LLCs are taxed as partnerships. The PTE’s partners, members, or shareholders must be individuals, estates, trusts, or corporations.
Importantly, disregarded entities[2], such as single-member LLCs, may elect to be taxed as partnerships and pay the entity-level tax. Members of such disregarded entities should immediately consider converting their entities to a qualified entity by adding a partner or member that would cause the entity to cease to be disregarded. We believe that a married couple may break the single member status by each taking part of their interest as their separate property.
If members of a single-member LLC elect midyear to have their LLC treated as a partnership, they will have to file two short year Forms 586 and pay the $800 annual tax for each short year. Given that it is late in the year, a single member LLC should set to make the change effective January 1, 2022.
[1] Assembly Bill 150 passed July 16, 2021
[2] A disregarded entity has only one member (or a couple filing a joint return) and the entity does not file a tax return, but the member reports the entities income and expenses on their 1040.
