There was certainly lots for taxpayers to love about former President Trump’s Tax Cuts and Jobs Act (TCJA) tax legislation.

But a couple of elements in Trump’s plan ambitions plan left many California residents less than thrilled. One aspect, in particular, is the cap on federal income tax deductions for state and local taxes, commonly known as the SALT deduction.

Prior to Trump’s TCJA legislation, you could deduct a significant portion of SALT (state and local taxes) on your annual income tax return.

TCJA, however, capped this deduction at $10,000 annually. And while some consider SALT deductions to be a “handout to the rich,” in high-income tax states, like California (which currently has the highest state taxes in the US), this cap hits a lot more folks in the wallet.

Fortunately for those impacted by the SALT deduction cap, Governor Newsom recently signed into law AB150.

AB150 — The SALT Cap Workaround

Ever mindful of California’s top tax rate, Governor Newsom worked with the California state legislature to create Assembly Bill 150.

This legislation gives qualified entities the option to pay taxes on “pass-through” income at the entity level.

Thus, for state income taxes due as of January 1, 2021, and running through January 1, 2026, qualified entity managers or partners can elect to pay the tax on their share of net income for that qualified entity.

What’s a “Qualify Entity?”

For those unfamiliar, this refers to formal business arrangements. When an individual or group of partners decide to form a business, there are a number of ways in which they can legally codify and register their business formation.

AB150 defines qualified entities as partnerships, limited liability companies with multiple members treated as a partnership, and S corporations.

What Are Business Entities Left Out?

Any publicly traded entities are disqualified. As are entities either allowed to or required to exercise group income reporting.

What’s The Elective Pass-Through Tax Rate?

Qualified entity owners must agree to a 9.3% tax rate on their share of the entity’s net income. And each entity partner must elect individually to pay this rate.

That said, even if one or more entity partners do not elect to take advantage of the pass-through option, the remaining partners are still eligible to pay the elective 9.3% pass-through income tax rate.

How Does The AB150 Workaround Help Taxpayers?

Different taxation rules apply to partnership entities. Unlike with individual taxpayers, state taxes paid by qualifying entities (as defined in AB150) can be deducted on federal income tax returns.

And as such, entity partners that elect to pay the pass-through state tax rate are not subject to the $10,000 SALT cap applicable to individuals.

Does The SALT Workaround Make Sense For You?

If your state taxes would grant a deduction higher than the $10,000 cap, and you’re a manager or partner of an entity qualified to accept the pass-through income taxation option, the answer is likely yes.

Also, if you’re a business owner or independent contractor and your state taxes would grant a deduction higher than the $10,000 cap, but your business is not organized as one of the qualifying entities, it may be worth considering doing so.

Of course, these situations are never as straightforward as they same. And as always, it’s best to confirm with a qualified tax professional.

Fortunately, I’m here to help! Get in touch here for your FREE consultation!