I heard that California passed a new law letting LLC owners deduct some or all of CA income taxes FROM their LLC, this avoids the cap on blue state IRS deductions. yes?
ChatGPT said:
Yes, California has implemented a workaround to the federal $10,000 cap on state and local tax (SALT) deductions for individual taxpayers. This provision allows certain pass-through entities, such as LLCs taxed as partnerships or S-corporations, to elect to pay a 9.3% state tax at the entity level on each consenting owner's share of qualified net income. This entity-level tax is deductible on the entity's federal tax return, thereby reducing the federal taxable income passed through to the owners. Subsequently, owners receive a nonrefundable credit on their California personal income tax return equal to the amount of tax paid on their behalf by the entity.
This election is available for tax years beginning on or after January 1, 2021, and before January 1, 2026. It's important to note that the election is irrevocable for the taxable year and must be made annually on a timely filed return. For tax years beginning in 2022 through 2025, the elective tax is due in two installments: the greater of $1,000 or 50% of the tax paid in the prior year is due by June 15 of the taxable year, and the remaining amount is due on or before the due date of the original return (without regard to extensions).
Not all entities qualify for this election. Eligible entities include partnerships, LLCs taxed as partnerships, and S-corporations whose owners are individuals, fiduciaries, estates, trusts, or entities taxable as corporations. Entities with partnership owners, publicly traded partnerships, or those required to be in a combined reporting group are excluded. Additionally, all owners are not required to consent; the election can be made on behalf of consenting owners only.
Given the complexities and specific requirements of this election, it's advisable to consult with a tax professional to determine if this option aligns with your tax situation and to ensure compliance with all relevant deadlines and procedures.
You said:
ChatGPT said:
Certainly! Let's illustrate how California's Pass-Through Entity (PTE) elective tax can help mitigate the federal $10,000 SALT deduction cap.
Scenario Without PTE Election:
- California State Income Tax Paid: $20,000
- Federal SALT Deduction Allowed: $10,000
- Non-Deductible State Tax: $10,000
In this situation, you're unable to deduct $10,000 of your state taxes on your federal return due to the SALT cap.
Scenario With PTE Election:
Assume your LLC has a qualified net income of $215,054. By electing to pay the PTE tax:
- PTE Tax Paid by LLC (9.3% of $215,054): $20,000
- Federal Deduction at Entity Level: $20,000
- Reduced Federal Taxable Income Passed to You: $195,054 ($215,054 - $20,000)
- California Taxable Income: $215,054 (PTE tax is added back)
- California Personal Income Tax Credit: $20,000 (non-refundable, can be carried forward up to 5 years)
Impact:
- Federal Return: The $20,000 PTE tax paid by the LLC is deductible at the entity level, reducing your federal taxable income by that amount. This effectively bypasses the $10,000 SALT cap, allowing the full $20,000 to be deducted.
- California Return: You report the full income of $215,054 but receive a tax credit equal to the PTE tax paid on your behalf, offsetting your California personal income tax liability.
Key Considerations:
- Election Timing: The PTE election is irrevocable for the taxable year and must be made annually on a timely filed return.
- Payment Deadlines: For tax years 2022 through 2025, the elective tax is due in two installments: the greater of $1,000 or 50% of the prior year's PTE tax paid by June 15, and the remaining amount by the original return due date.
- Non-Refundable Credit: The California tax credit is non-refundable but can be carried forward for up to five years if it exceeds your state tax liability.
This strategy allows you to convert a non-deductible state tax expense into a deductible business expense at the federal level, potentially reducing your overall federal tax liability. However, it's essential to consult with a tax professional to ensure this election aligns with your specific tax situation and to navigate the complexities involved.
You said:
ChatGPT said:
Yes, there is a possibility that your effective California personal income tax rate could be lower than the 9.3% Pass-Through Entity (PTE) elective tax rate, especially considering California's progressive tax brackets.
California's Progressive Tax Rates:
California's personal income tax rates for 2024 are progressive, ranging from 1% to 13.3%, depending on taxable income.
Comparison with PTE Elective Tax:
The PTE elective tax imposes a flat rate of 9.3% on the qualified net income of the pass-through entity.
Potential Scenarios:
Lower Effective Tax Rate: If your taxable income places you in a bracket with an effective tax rate below 9.3%, electing the PTE tax could result in paying more state tax than you would under the individual progressive rates.
Higher Effective Tax Rate: If your taxable income falls into higher brackets, with rates exceeding 9.3%, the PTE election could be advantageous, as you'd pay the lower 9.3% rate on your pass-through income.
Considerations:
Non-Refundable Credit: The PTE tax credit is non-refundable but can be carried forward for up to five years. If the credit exceeds your California tax liability, the excess can be applied to future tax years.
Federal Deduction: The PTE tax paid is deductible at the federal level, potentially reducing your federal taxable income.
Recommendation:
Given the complexities and the interplay between federal and state tax implications, it's crucial to consult with a tax professional. They can analyze your specific income situation to determine whether electing the PTE tax aligns with your financial goals and results in overall tax savings.
You said:
ChatGPT said:
Yes, you're correct. California's personal income tax rates are progressive, ranging from 1% to 12.3%, with an additional 1% Mental Health Services Tax on income over $1 million, bringing the top marginal rate to 13.3%.
The 9.3% Pass-Through Entity (PTE) elective tax is a flat rate applied to the qualified net income of the pass-through entity. Depending on your individual taxable income, your effective state tax rate could be lower or higher than 9.3%.
Considerations:
Income Levels Below 9.3% Bracket: If your taxable income places you in a bracket with an effective tax rate below 9.3%, electing the PTE tax could result in paying more state tax than you would under the individual progressive rates.
Income Levels Above 9.3% Bracket: Conversely, if your taxable income falls into higher brackets, with rates exceeding 9.3%, the PTE election could be advantageous, as you'd pay the lower 9.3% rate on your pass-through income.
Recommendation:
Given the complexities and the interplay between federal and state tax implications, it's crucial to consult with a tax professional. They can analyze your specific income situation to determine whether electing the PTE tax aligns with your financial goals and results in overall tax savings.
