ABC cannot make the election because it has a partnership owner – not an eligible owner. To illustrate, consider talent management company ABC that is taxed as a partnership, owned one-third each by Adam (an individual), Bill (an individual), and Partnership CD owned by Chuck and Dan. Herein lies a key limitation – a pass-through entity with even one ineligible owner is disqualified. A 'Qualified Entity' means (1) an S-corporation or an entity taxed as a partnership, such as a multi-member limited liability company, whose owners are only (2) individuals, corporations, trusts, and estates.

Under AB-150, effective for tax years beginning January 1, 2021, a 'Qualified Entity' can elect annually to pay California income tax on behalf of its owners at a rate of 9.3% on its California sourced income for years beginning in 2021 through 2025. While AB-150's elective tax work-around appears quite favorable to California residents, the devil is always in the details, which we address below. Moreover, as we noted in our prior post regarding an earlier proposed version of the elective tax, the IRS surprisingly has blessed these elective entity-level state tax regimes in IRS Notice 2020-75. The benefits could be massive for pass-through entity owners who can take advantage of this work-around.

If so elected, the entity takes the deduction for the state tax paid without limit, reducing the federal taxable income passed through to the owners, and the owners receive a California income tax credit for the tax paid by the entity that avoids the same income being taxed twice. On July 16, Governor Gavin Newsom signed into law Assembly Bill 150 (AB-150), which includes a mechanism for certain pass-through entities to elect to pay California income tax on behalf of their individual, estate, and trust owners with their consent. While Congress has stalled on passing legislation that would eliminate, in whole or in part, the current limit on an individual taxpayer's ability to take the itemized deduction for state and local taxes, California has taken a dramatic step toward allowing many of its residents to mitigate the effects of the $10,000 federal limit on that deduction implemented under the Tax Cuts and Jobs Act.

Ca 2021 tax brackets