Over the past several years tax practitioners in California, among other states, have been advising clients on the implications of the pass-through entity elective tax (PTE), and how it can be a good option for tax minimization in the right circumstances. However, as is common with new tax laws, there have been some questions and pain points surrounding PTE’s implementation. 

The California Legislature, with feedback from the FTB, practitioner groups including CalCPA and other interested parties, is considering updates to the PTE-related statutes currently in place.

As a refresher, the California PTE is available for taxable years beginning on or after Jan. 1, 2021, and before Jan. 1, 2026. This so called “SALT workaround” has allowed certain pass-through entities with qualified taxpayers subject to California personal income tax, to pay California income taxes on behalf of participating partners, members or shareholders (herein referred to as “partners”) and in most cases shift the associated federal tax deduction from Schedule A (Itemized Deductions) to Schedule E (Supplemental Income and Loss).

The participating partners receive a California tax credit (via CA Schedule K-1) for their allocable share of the PTE payments made by the entity. 

One significant criticism of the initial PTE legislation is that the stringent June 15 payment requirement causes confusion and frustration to taxpayers who miss or underpay the June 15 payment. Revenue and Taxation Code (R&TC) Sect. 19904 clearly requires a mandatory payment “on or before June 15 during the taxable year of the election, an amount equal to, or greater than, either 50 percent of the elective tax paid the prior taxable year or one thousand dollars ($1,000), whichever is greater.” If the June 15 deadline is missed or underpaid, then the election is not available for the year under current law.

Overview of Proposed Legislative Changes

Senate Bill 1501, introduced Feb. 16, 2024, by California Sen. Steve Glazer (D-Orinda), aims to amend various Sections of the R&TC, particularly in regard to PTE and its required June 15 payment date. As of the time of this publication, SB 1501 is being held in suspense by the Senate Appropriations Committee and is not likely to move forward before the end of the year. If passed, the proposed changes to the PTE program are only in effect for tax years 2024 and 2025.

SB 1501, as it currently stands in Committee, would make the following noteworthy changes:

1. Eliminate the mandatory June 15 deadline, meaning if a payment is not made by June 15, the PTE election could still be made for the calendar year in question.

2. Impose interest (to the electing entity) on the amount of the prepayment that was unpaid or underpaid for the period that begins on June 15 that the prepayment was due and ends on the day of payment. The interest rate employed would be the underpayment rate for non-corporate taxpayers pursuant to IRC Sec. 6621, currently 8 percent.

3. Reduce the state tax credit (to the partner) when the entity makes a June 15 payment that is less than the amount due. In the case of an entity that does not make the June 15 payment, the resulting credit would be the typical 9.3 percent credit, reduced by 10 percent. In the case of an entity that makes a June 15 payment that is less than the required amount (greater of 50 percent prior year or $1,000), the resulting credit would be the typical 9.3 percent credit, reduced by an amount equal to 10 percent of the amount due but not paid by June 15.

Examples of How the Proposed Legislative Changes Would Operate

Example 1:
June 15th payment less than required
Limited partnership “A” wishes to elect into PTE for 2024

• 2023: A elected into PTE for 2023 and that year’s total PTE liability was $40,000

• 6/15/2024 payment due: $20,000 (greater of 50 percent of the 2023 PTE amount or $1,000)

• 6/15/2024 payment actually made: $5,000

• Date payment made: Aug. 15, 2024 ($15,000 remaining due)

• Result to entity: A would be charged roughly $201 in interest (8 percent interest on $15,000, compounded daily for 61 days).

• Result to partners: As the June 15 amount was underpaid by $15,000, the credit available would be reduced by $1,500 ($15,000 underpaid amount times 10 percent).

Example 2:
June 15th payment not made
S Corp “B” wishes to elect into PTE for 2024

• 2023: B elected into PTE for 2023, and that year’s total PTE liability was $40,000

• 6/15/2024 payment due: $20,000 (greater of 50 percent of the 2023 PTE amount or $1,000)

• 6/15/2024 payment actually made: $0

• Date payment made: March 15, 2025—actual liability of $50,000 for the year, based upon qualified net income (QNI

• Result to entity: B would be charged roughly $1,233 in interest charges (8 percent interest on $20,000, compounded daily for 273 days).

• Result to shareholder(s): As the June 15 amount was not paid, the credit available would be reduced by $5,000 ($50,000 times 10 percent).

Example 3:
Significant decrease year
Entity “C” wishes to elect into PTE for 2024, but expects a significant decrease in QNI. Projected QNI for 2024 = $1M, versus 2023 QNI = $6M

• 2023: C elected into PTE for 2023, and that year’s total PTE liability was $558,000

• 6/15/2024 payment due: $279,000 (greater of 50 percent of the 2023 PTE amount or $1,000).

• 6/15/2024 payment (option 1): $279,000

• Result to entity (option 1): If C’s 2024 qualified net income ends up being only $1M, then the overall 2024 PTE liability will be $93,000. C would ultimately have overpaid the PTE by $186,000 ($279K payment less $93K liability) and would have to wait until the 2024 tax return is filed to receive a refund.

• Result to partners: no reduction in credit of $93,000

• 6/15/2024 payment (option 2): $93,000

• Result to entity (option 2): Uncertain. Under current language, the underpaid June 15 amount is $186,000, but would interest charges accrue to March 15, 2025, since the final PTE liability was already paid in full?

• Result to partners (option 2): Uncertain. Does the credit get reduced since the final PTE liability was already paid in full?

One key takeaway from each of these examples is that even though the entities in question missed, in whole or in part, the June 15 payment date, they would still be eligible to elect into PTE for 2024 under the proposed legislative framework.

Unanswered Questions and What’s Next

After hearings on the bill on Aug. 7 and Aug. 15, SB 1501 was left in suspense by the Senate Appropriations Committee and is unlikely to see additional activity this year. However, this or similar legislation may move forward in 2025.

A few unanswered questions in the authors’ mind are:

1. In a decline year, will the entity’s interest charge calculation stop accruing when the tax return is filed on (or before) March 15 of the upcoming filing season, when an entity chooses to not make an excessive June 15 payment? Or would there be some provision to base the underpayment based upon the lower qualified net income of the current year?

2. Does the 10 percent credit reduction pertain to each partner or is the reduction shared pro-rata amongst the electing partners?

Tax practitioners should pay close attention to final changes outlined in SB 1501 or similar future legislation, if passed into law, so that they can advise clients as to appropriate strategies for the coming tax years.