The Tax Cuts and Jobs Act (TCJA) passed in 2017. It modified the Internal Revenue Code of 1986 and, among other things, imposed a $10,000 deduction cap on state and local taxes (SALT) until 2025. The One Big Beautiful Bill Act then raised the cap to $40,000 for taxpayers who make less than $500,000. For many California businesses, however, this deduction cap has led many business owners to pay income taxes twice each year.
California responded to this deduction cap by establishing a Pass-Through Entity (PTE) elective tax. This tax allows pass-through business owners to legally bypass the cap and deduct SALT payments from their federal income taxes, saving them money in the long run. However, navigating the PTE elective tax can be a complex process. This article walks you through the basics of the pass-through entity tax in California so you can maximize SALT deductions in 2025.
The California PTE tax is an optional state tax that qualifying pass-through business owners and members can opt into each year. It is part of California Assembly Bill 150 (AB 150), creating a workaround to minimize the extra costs for pass-through business owners and members. This bill was signed into law in 2021 as a direct response to the TCJA, which limits how much taxpayers can deduct from their federal taxes based on taxes paid at the state and local levels. As a result, many have had to pay double what they usually would.
Only owners and members of pass-through businesses can opt into the PTE tax. However, many businesses in the U.S. are considered pass-through businesses. In California specifically, private partnerships and S corporations are legally designated as pass-through businesses because their income and losses are all passed through directly to the owners, shareholders and other members of the business.
Traditionally, this income is taxed to the individuals directly, not the business entity as a whole. The PTE tax allows businesses to invert this system. The entity is taxed, rather than the individual, which then lets pass-through businesses to deduct the entire SALT payment from their federal income taxes. This deduction lowers the business's net income for tax purposes, decreases the taxable income on the applicant's tax return and awards them with a nonrefundable AB 150 tax credit on their state income tax return.
Now that you know what the PTE tax in California is, let's look at a specific example of how the process works.
Let's say you own a successful S corporation, and you owe $12,000 in personal income taxes to California and $20,000 in federal income taxes. Because of the TCJA, you can only deduct $10,000 of your state payment from your federal income tax. As a result, you pay $12,000 to California and $10,000 federally rather than the $8,000 you would pay if you could deduct the whole state amount. In essence, you pay $2,000 to the state and the federal government on the same income.
However, you could opt into California's PTE tax to avoid this deductible cap. First, file a 2025 Pass-Through Entity Elective Tax Payment Voucher (FTB 3893) form with the California Franchise Tax Board. They then charge a 9.3% qualified income tax to your S corporation as a whole rather than to you as an individual.
The S corporation can deduct the entire tax payment from its federal tax return as a business expense, lowering its net income and your taxable income for your personal federal tax return. You also receive a tax credit you can use to reduce the cost of your state income tax.
This process saves you money at both the federal and state levels, which you can funnel back into your S corporation or use for other expenses.
Evaluating your business's eligibility for the California PTE tax is relatively simple. Two primary legal entities qualify — S corporations and private partnerships. Disregarded single-member limited liability companies (LLCs) owned by individuals, fiduciaries, estates or trusts that pay personal income taxes are also eligible. Within these entities, you must be a shareholder, partner or member who pays personal income tax in California to qualify for the PTE elective tax.
The following legal entities do not qualify:
If you qualify, however, ensure you are comfortable with the PTE tax. Once you have opted into it, all consenting partners and members are bound by that decision for that tax year.
Before opting into the PTE tax, ensure you understand the associated deadlines for 2025. Missing any of them can mean forfeiting the PTE tax entirely, so be sure to track each one.
The most important deadlines include:
The PTE tax process can be both rewarding and complex. SD Mayer helps you tap in to those rewards by monitoring shifting tax regulations and recommending the most effective course of action for your business. For over a decade, we have been helping businesses in various industries succeed in an increasingly challenging market. Our proactive, professional team offers services for auditing, tax filing and business advisory so you feel confident in every aspect of your decision-making.
To learn more about filing for PTE taxes with SD Mayer, fill out our contact form or call us at 415-691-4040.
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