California AB150: tax credit for flow-through entities
The State of California introduced the California Assembly Bill (CA AB150) in response to the federal Tax Cuts and Jobs Act (TCJA) of 2017. California Assembly Bill (2021) helps reduce the effect of the $10,000 limit on state and local tax deductions for certain businesses.
This article overviews AB150 California and how it can help small business owners save tens of thousands of dollars on federal taxes.
What is AB150?
California Assembly Bill 150 (AB150) was created in response to the federal Tax Cuts and Jobs Act. It limits state and local tax deductions to $10,000 per taxpayer. This act significantly affected California small business owners by raising their federal tax liability.
The AB150 was designed to counter the federal tax deduction limitation on state and local income taxes. California Assembly Bill 150 allows pass-through entities to pay an entity-level tax on their California taxable income from 2021 through 2025.
California AB150 explained
As a business owner, you can prepay the state of California for the taxes you expect to owe. At the end of the year, you receive money as credit. This money is a legitimate business expense and lowers your taxable income for federal taxes.
The following example illustrates how to file taxes under the AB150 legislation.
For instance, you are an LLC in California and earn $500,000 in annual income. Your share of the LLC's income is $250,000, and you pay $25,000 in state taxes. Under California AB150, you can pay the state taxes at the entity level on behalf of the LLC – your LLC pays the state $25,000 directly. On your federal tax return, you can deduct the $25,000 paid by the LLC as a business expense, reducing your taxable income at the federal level from $500,000 to $475,000.
The AB150 allows you to transfer state taxes from your personal tax return to the LLC's return. This can decrease your federal taxable income and lower the amount of federal tax you owe.
Who qualifies for AB150?
The AB150 applies to you if you own a pass-through business entity that can be a partnership, a multi-member LLC taxed as a partnership, an S corporation, or an LLC taxed as an S corporation.
Businesses must also meet specific criteria, like being a pass-through entity for federal taxes and earning income in California.
Every year, the entity must decide whether to pay state taxes at the entity level. Qualified taxpayers must also follow the rules and deadlines the California Franchise Tax Board sets.
Publicly traded partnerships, C corporations, and sole proprietorships do not qualify for AB150.
AB150 for small businesses: benefits & considerations
The AB150 benefits individual owners of pass-through entities by giving them credit on their California tax returns. The prepaid state tax at the entity level is a legitimate deduction that can significantly reduce the total taxable income subject to federal income tax.
Consider California Assembly Bill 150 alongside other tax laws and regulations because of its complex legislation. For example, lowering federal taxable income with state taxes may impact deductions like Qualified Business Income (QBI).
Deadline for AB150 payments
The AB150 payments are due in installments, with specific due dates outlined by the California Franchise Tax Board.
To be eligible, you must make estimated payments toward that balance throughout the year. The pass-through entity tax return must be filed before the year-end. The actual tax payment is due by the original tax deadline.
Also read. Small business tax deadline: 2023 tax year
Changing an entity-level tax after you elect it may be complicated until the next tax year.
Entity-level taxation in California may be a handy option for pass-through businesses to reduce their tax burden. However, it requires forethought and strategic business tax planning.
Avoid surprise taxes and penalties. Get a tax planning consultation.
Learn moreFAQ
California AB150 is a legislative measure that aims to provide relief to pass-through entities in California by allowing them to elect to pay an entity-level tax on their California taxable income. This tax aims to mitigate the impact of the limitations on state and local tax deductions imposed by the federal Tax Cuts and Jobs Act (TCJA).
Small businesses operating as pass-through entities, such as partnerships, multi-member LLCs, and S corporations, qualify for AB150.
AB150 benefits small businesses by allowing them to reduce their federal tax liability. By electing to pay the entity-level tax in California, owners of pass-through entities can alleviate the impact of the TCJA's $10,000 limitation on state and local tax deductions.
Potential drawbacks of electing AB150 include the need for careful consideration of its impact on federal tax deductions and overall tax planning strategies. Additionally, once the election is made, it may be irrevocable until the next tax year, so small business owners should weigh the decision carefully.
Small business owners have the option to pay the entity-level tax under AB150. They can do this by following the steps provided by the California Franchise Tax Board. This process involves the timely filing necessary forms and adherence to specific deadlines.
Disclaimer: This article is for informational purposes only and does not constitute legal or tax advice. Always consult with a tax professional regarding your specific case.
Susan Turcotte, a seasoned CPA with over 45 years of accounting experience, holds a Bachelor's in Accounting and a Master's in Taxation from Bryant College. See more
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