June 09, 2024

A short summary of California PTET

The PTET, a recently enacted California law, may offer certain business owners a tax-saving opportunity. In this blog post, I will give a brief overview of how to compute the tax and interpret its appearance on your tax return. Let's dive in.

How do we calculate the tax to pay?

To calculate the tax, the first step is to determine the "qualified net income" for the business on California level. This information can be taken from a draft of California business return if you have one. Next, calculate how much of that income belongs to you personally (that is, if you have other business partners and you are not a hundred percent owner). Finally, multiply your share of the income by the tax rate (which is currently 9.3%) to get your pass-through tax owed. For example, if you see on the California 100S K-1 form that your share of income is $100,000, then you would pay $9,300 in the pass-through tax.

How does this credit work?

A qualified pass-through entity deducts California taxes on its federal return, which lowers the entity's taxable income. The reduced taxable income flows to the K-1 recipient on their individual return and the taxpaer pays less in taxes. However, the state tax is added back to the income on the California tax return, and California taxes you on the original amount of income prior to the deduction. You still receive a tax credit for the tax they paid on their personal California tax return.

When to make a payment?

For the 2022 through 2025 taxable years, the entity must make two payments. The first payment is due by June 15 of the taxable year and is the greater of 50% of the elective tax paid for the previous year or $1,000. The remaining amount is due by the entity's original filing date deadline (March 15 for calendar-year taxpayers). If the June prepayment is underpaid, the taxpayer is ineligible to make the election for that taxable year.

When to deduct the tax?

The entity should deduct the tax in the year it is paid. Therefore, even if you are allowed to wait till March 15th of the next year to make a final payment, it is advisable to make this payment in the end of December of the current year. This way you get a benefit of a deduction on current taxes. For example, if you paid the PTET tax in 2022 for the 2021 tax year, the payment would be only deducted on the entity's 2022 tax return and reflected on the 2022 K-1 form. The 2021 tax return will stay untouched. However, the California tax credit would still apply to the 2021 tax year.

How to make an election?

To make an election, the first step is to make a payment prior to June 15 of the current year as we discussed above. When filing the tax return, attach form 3804 to your California return, which should include the list of all owners for whom the tax was paid and the amount paid on their behalf. Keep in mind that once you have filed your original tax return and the deadline for filing has passed, you cannot file another return to make, revoke, or modify the election amount.

How to report a payment on California return?

Electing LLCs: The total amount of the elective tax that was previously paid in with the Form FTB 3893, or through Web Pay, is reported on Form 568, line 9. Any additional amounts that must be paid with the return are reported on Form FTB 3804, Part I, Elective Tax, line 3 and on Form 568, line 4.

Electing partnerships: The total amount of the elective tax that was previously paid in with the Form FTB 3893, or through Web Pay, is reported on Form 565, line 30. Any additional amounts that must be paid with the return are reported on Form FTB 3804, Part I, Elective Tax, line 3 and on Form 565, line 25.

Electing S corporations: The total amount of the elective tax that was previously paid in with the Form FTB 3893, or through Web Pay, is reported on Form 100S, line 35. Any additional amounts that must be paid with the return are reported on Form FTB 3804, Part I, Elective Tax, line 3 and reported on Form 100S, line 29.

To summarize, California's pass-through entity tax allows businesses to save money on taxes by electing to pay California tax on behalf of its owners. The tax amount is deducted on the entity's federal return, which lowers taxable income, and the reduced taxable income flows to the K-1's recipient, resulting in lower taxes. The entity must make two payments and deduct the tax in the year it's paid. To make an election, a payment must be made before June 15th of the current year, and form 3804 must be attached to the California return.