Pass-Through Entity Elective Tax:
What It Is and How It Can Help You

A pass-through entity (PTE) is a business structure in which the business income “passes through” to the owners, who then reports the income on their personal tax returns. This is in contrast to a C corporation, in which the business itself pays taxes on its profits.

There are several advantages to operating as a pass-through entity. Firstly, PTEs can help owners save on taxes by allowing them to deduct business expenses from their personal income. 

Secondly, pass-through entities offer flexibility in how owners can distribute profits among themselves. And finally, pass-through entities provide owner-operators with personal liability protection from any liabilities incurred by the business.

Who Can Qualify As A Pass-Through Entity?

To qualify as a PTE, businesses must meet certain criteria. For example, they must be organized as partnerships, limited liability companies (LLCs), or S corporations. 

Definition of A Qualified Taxpayer Under PTE Law

To qualify as a PTE, you must firstly be a qualified taxpayer. A qualified taxpayer is any person or entity that meets the requirements to be taxed as a pass-through entity. The following are some of the key criteria used to determine if a taxpayer is qualified as a pass-through taxpayer under PTE law or not:

What A Qualified Taxpayer Is

To be a qualified taxpayer, you must be a partner, shareholder, or member that is subject to California personal income tax. Or alternatively, you must be a disregarded single-member LLC that is subject to California personal income tax.

What A Qualified Taxpayer Isn’t

Under PTE law, your business cannot be a disregarded business entity, which is a business that is not considered separate from its owners for tax purposes. Other types of entities that aren’t considered as qualified taxpayers under PTE law include corporations and partnerships.

Disqualifications

There are a few factors that can disqualify your company from qualifying as a pass-through business. If your business is a publicly-traded partnership or an entity that is required or allowed to be in a combined reporting group, then you will be disqualified from qualifying as a PTE.

PTE Election Terms

The basic terms and conditions of the PTE election are as follows:

  • You must file an annual return with the IRS
  • You must file a statement with your return indicating that you are making the PTE election
  • You must attach a schedule to your return detailing your business income and expenses
  • All shareholders, partners, or members of your business must consent to the PTE election
  • You must notify the IRS of any changes in your business status that could affect your PTE election
  • You must make the election when you file your tax return for the taxable year after January 1, 2021, and before January 1, 2026. The first payment of PTE tax is due June 15 of each year, with the balance due with the filing of the tax return for that year.

How The Tax Is Calculated

The elective tax is 9.3% of the entity’s qualified net income. The tax is imposed on the sum of the pro rata shares (which is the portion of the profit that each member is allocated) of the net income attributed to shareholders, partners, members, or owners consenting to the election.

How To Pay

There are two ways that you can pay the PTE tax. You can make a payment electronically using Web Pay or you can print a tax payment voucher (FTB 3893) from the Franchise Tax Board (FTB) website, which you can then mail to the FTB. Keep in mind that the payment will remain as a PTE elective tax once you make the payment until a tax return is filed.

Considerations Before The Election

There are a few things that you should consider before you decide to make yourself eligible for pass-through entity election under California tax law. These include:

  • Non-resident issues: In other states, non-residents may not be able to take advantage of the PTE rules. However, this is not necessarily the case in California.

    In California, not all of the owners of an entity electing to become a PTE need to be included. This may be advantageous for businesses with out-of-state owners who would not otherwise benefit from the PTE rules.

  • Qualifications for other tax credits: Some businesses may also qualify for other tax credits or deductions that can help reduce their overall tax liability. Be sure to model potential results to anticipate your ability to use the credit carryover within the limited five-year period.
  • Non-resident withholding: Entities who elect into the PTE tax are responsible for remitting withholding for any partners that are non-residents. If there are any non-resident owners that consent to the PTE, they should reduce any possible double remittance by applying for a non-resident withholding waiver exemption.
  • Disregarded entities: Although having a partner or member that is considered a disregarded entity won’t disqualify you from making a PTE election, disregarded entities will not be eligible for the PTE tax credit in California.
  • Types of partnerships: Businesses with tiered partnership structures are not excluded from participating in PTE. However, the share of income of an upper-tier partnership can’t be included in the qualified entity tax base, nor can an upper-tier partnership owner receive a California PTE tax credit.

    Additionally, as long as you meet California’s definition of a qualified entry, general partnerships are eligible for the PTE election.

How To Claim Your Tax Credits Under A PTE

To claim your tax credits under a PTE, you will need to file a return with the Franchise Tax Board. The form that you will need to use will depend on the type of business entity that you have, your income for the year, and whether or not you are making an annual or quarterly payment. 

Generally, you will need to provide information about your business income, deductions, and any other tax credits that you are claiming in order to calculate your final tax liability.

The Limits Of PTE Tax Credits

While the tax credits offered under the PTE rules can be extremely beneficial to businesses, it is important to note that there are certain limitations in place. 

  • Amount of tax credit to be claimed: The amount of tax credit that can be claimed by businesses under the PTE rules is capped at $1 million. This means that businesses will not be able to claim more than $1 million in tax credits in a given year.

Do PTE Tax Credits Have An Expiration Date?

Once a business has elected to become a PTE, they will be able to claim the associated tax credits for a period of five years.

However, it is important to note that these credits will not be available indefinitely, and businesses should make sure to take advantage of them while they can. If a business no longer qualifies under the PTE rules, they will need to end their election or they may face penalties. 

As such, businesses should carefully consider their decision to become a PTE and make sure that it is the right choice for their situation.

How J.R. Martin Can Help You

If you are a business that is considering becoming a pass-through entity, our team at JR Martin CPA can help. Our experienced accountants are well-versed in state and federal tax laws and regulations governing PTEs. We can work with you to determine whether this type of election is the right choice for your business.

We will help you to understand the benefits of PTE and can guide you through the process of electing, allowing you to take advantage of the many benefits that a PTE status can offer. The following are a few specific ways that we can help:

Discuss Consent For Election

To elect to become a PTE, businesses must obtain consent from their owners and file a consent form with the relevant tax authorities. This may involve obtaining approval from a majority of all of the owners, depending on the business structure. At J.R. Martin CPA, we can help you to navigate the consent process and ensure that you have all of the necessary paperwork in place.

Decode Tax Laws

Our team at JR Martin CPA is experienced in decoding tax laws and can help businesses to understand how the PTE rules apply to their specific situation. We will help you to understand the benefits of a PTE and can provide guidance on the tax filing process, including how to claim PTE-related tax credits. 

Additionally, our experts can help you to understand the potential implications of your PTE status and can provide advice on how to minimize your tax liability.

Find Opportunities For Maximized Tax Credits

In addition to helping businesses understand the tax implications of PTE, we can also help you to take full advantage of the available tax credits and deductions. Our experts are well-versed in the various tax credits that may be available to PTEs and can help you to identify opportunities for maximizing your credits. 

We will work with you to ensure that you are taking advantage of all available tax benefits and help you to minimize your overall tax liability.

Compile Relevant Financial Records

In order to file your taxes as a PTE, you will need to compile relevant financial records, including income and expenses. At J.R. Martin CPA, we can help you to gather these records and organize them in a way that makes it easy for tax authorities to review. Additionally, we can help you to understand what records you will need to keep in order to comply with PTE tax rules.

Fill Out And File Important Forms For Your Company

Finally, we can help you to fill out and file the appropriate tax forms for your company. This includes filing the necessary documentation to elect PTE status as well as the forms required to claim PTE-related tax credits. We will ensure that all of the necessary paperwork is filed correctly and in a timely manner, minimizing the risk of penalties and other issues.

Make The PTE Election Work For Your Business

If you are a California-based business that is thinking about becoming a PTE, it is important to consult with experienced tax professionals to ensure that you are taking advantage of all available benefits. 

At J.R. Martin CPA, we have the expertise and experience to help businesses understand how California tax laws can benefit their business and maximize their tax credits. With our help, you can make the PTE election work for your business and take full advantage of the benefits that a PTE status can offer.

Fill out the form on the right to learn more about how pass-through entity elections can work for your business.

Schedule A Call Today!
  • This field is for validation purposes and should be left unchanged.