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May 17, 2021

California elective pass-through entity tax bill continues through state Senate after significant technical corrections and amendments

A bill introduced earlier this year in the California legislature (SB 104) that would establish an elective pass-through entity (PTE) tax has been significantly amended. This new PTE-level tax, if adopted, is intended to enable California taxpayers who are owners of PTEs, such as partnerships and S corporations, to deduct, for federal income tax purposes, state and local taxes exceeding the $10,000 limitation imposed by IRC Section 164(b)(6) (the "SALT deduction limitation"), consistent with IRS Notice 2020-75 (see Tax Alert 2021-0092). The legislatively-stated goal of the PTE tax is to provide tax relief to small businesses facing unprecedented economic hurdles due to COVID-19.

SB 104 was initially introduced in the state Senate on January 5, 2021, and was significantly amended by the Senate Committee on Appropriations (Committee) on April 12, 2021. As amended, SB 104 would allow a qualifying PTE doing business in California to annually elect to pay a 9.3% tax1 according to, or measured by, the PTE's net income for the tax year for which the election is made. As a result of the elective tax paid, a "qualified taxpayer" would be allowed a credit of 94.9% of the "qualified amount"2against the "net tax."3 The amended SB 104 would substitute a tax credit mechanism for the owner's share of the elective PTE tax paid to avoid a potential double tax. This is a significant change from the original proposal in SB 104, which would have exempted the owner's share of the PTE's income subject to the PTE tax to eliminate a double tax at the PTE and personal income tax levels.

Under the Committee's amendment, a "qualified taxpayer" would include any individual, fiduciary, estate or trust subject to personal income tax under Part 10 of the CRTC (California's personal income tax)4 that is a partner, shareholder or member of the PTE (collectively, "PTE members")5 that is an "electing qualified entity" (i.e., an electing partnership, S corporation or LLC electing to be treated as a partnership or S corporation). A PTE that included a corporation, for example, would not be a "qualified entity" that would be eligible to elect into the PTE tax. Moreover, partnership entities that are not limited or limited liability partnerships and that are not "taxed" under CRTC Sections 18633 and 18633.5 (section 19900) would specifically be excluded from the definition of "qualified entity" under the Committee's amendments.6

"Electing qualified entities" would be PTEs that are business entities (1) taxed as partnerships or S corporations, (2) have PTE members that are exclusively qualified taxpayers and (3) have elected to pay the PTE tax. An electing qualified entity's election would be irrevocable once made and binding on all its members for the tax year.

The elective PTE tax would be due and payable on the original and timely filed return and would be in addition to any other required personal or corporate income tax. A taxpayer would be able to carry forward the amount of credit exceeding the "net tax" due to the following tax year, and the succeeding two years, if necessary, until exhausted.

SB 104 specifically provides that the PTE tax would be effective only until December 1, 2026.


In November 2020, the IRS issued Notice 2020-75 indicating its intention to issue proposed regulations clarifying that a partnership or S corporation computing non-separately stated taxable income or loss for federal income tax purposes could deduct state and local income taxes imposed on its net income for the tax year at issue without regard to the SALT deduction limitation (see Tax Alert 2020-2690). It was widely anticipated that most states would rush to enact an entity-level tax to provide the federal tax benefit to owners of PTEs in their states.7 California, among other states, has proposed such legislation since the IRS's announcement.8 On the same day SB 104 was initially proposed in January 2021, California Governor Gavin Newsom previewed his Equitable Recovery for California's Businesses and Jobs plan, which calls for mitigating the limitation on the state and local tax deduction for S corporation shareholders.9 SB 104, however, is more expansive than the Governor's proposal in that it would apply to certain entities taxed as partnerships, in addition to S corporations.

It is unclear whether the current list of qualifying PTEs is intended to exclude general partnerships, as these entities are not listed in the bill analysis for SB 104 and are not "taxed" as partnerships in California. SB 104 does not provide an explicit mechanism to credit California resident taxpayers for their distributive share of similar PTE taxes paid to other states, but the modification of the PTE tax to a credit for PTE members may enable California resident and nonresident taxpayers to utilize the other state tax credit provisions of CRTC Sections 18001 through 18006.

The provisions of SB 104 are subject to amendment as the bill continues to work its way through the legislative process.


Contact Information
For additional information concerning this Alert, please contact:
State and Local Taxation Group
   • Carl Joseph (
   • Todd Carper (
   • Jenica Wilkins (
   • Josh Booth (


1 As originally drafted, the rate of the proposed PTE tax was intentionally left blank.

2 The "qualified amount" would be defined as "an amount equal to 9.3[%] of the qualified taxpayer's pro rata share or distributive share, as applicable, of income subject to the [PTE tax] election made by an electing qualified entity … "

3 "Net tax" is defined by California Revenue & Taxation Code (CRTC) Section 17039 to refer to the personal income tax imposed on residents, nonresidents and part-year residents, less certain exemption credits and adjustments for interest on installment obligations.

4 See the definition of "taxpayer" in CRTC Section 17004. SB 104 specifically excludes partnerships from the definition of "qualified taxpayer."

5 This would apply to PTE owners who are residents, nonresidents or part-year residents of California.

6 See SB 104, Sec. 3 and specifically the provision that would add new CRTC Section 19902 (defining "qualified entity").

7 States that had already enacted PTE taxes (or PTE tax elections) before the Notice include Connecticut, Louisiana, Maryland, New Jersey, Oklahoma, Rhode Island and Wisconsin.

8 States that recently enacted electable PTE-level taxes include Alabama, Arkansas, Georgia, Idaho and New York. In addition to California, bills are being considered in other states, including Illinois, Massachusetts and Michigan.

9 See e.g., California 2021-22 Governor's Budget Summary 2021-22, Equitable and Broad-based Recovery - California Jobs Initiative - Small Businesses pg. 31 ("The Budget contains a provision that allows S-corporation shareholders a credit against tax equal to 13.3[%] of their S-corporation income in order to help them recoup some of the tax benefits lost by Californians when the State and Local Tax (SALT) deduction was limited as part of the 2017 federal Tax Cut and Jobs Act. The Elective S-corporation Tax is expected to on net to produce a [ ] revenue gain between $0 and $20 million starting in 2021-22."