California Budget Bill Enacts Elective Pass-Through Entity Tax & Other Tax Changes

California Gov. Gavin Newsom has signed a budget trailer bill that creates an elective pass-through entity tax, expands the small business hiring credit (also known as the Main Street Small Business Tax Credit), creates a homeless hiring tax credit, extends the taxable years for which the credits for rehabilitating certified historic structures may be claimed, and increases the amount of California Competes Tax Credits that may be allocated during fiscal year 2021–2022.

Elective Pass-Through Entity Tax

For taxable years beginning on or after January 1, 2021, and before January 1, 2026, a qualified entity that is doing business in California and required to file an S corporation return, a limited liability company return, or a partnership return may elect annually to pay an elective tax according to or measured by its qualified net income, computed at the rate of 9.3 percent for the taxable year for which the election is made. 

This elective tax is in addition to, and not in place of, any other tax required to be paid under California’s personal income tax or corporation tax laws, e.g., the 1.5 percent tax on S corps. The qualified entity may include in its qualified net income the pro rata or distributive share of the income of any of its partners, shareholders, or members upon their consent, but a partner, shareholder, or member who does not consent does not prevent the qualified entity from making an election to pay the elective tax. All partners, shareholders, and members of the qualified entity will be bound by the election for the taxable year. The election to pay the tax is irrevocable and will be made on an original, timely filed return for the taxable year of the election in a form and manner as prescribed by the California Franchise Tax Board.

For taxable years beginning on or after January 1, 2021, and before January 1, 2022, the elective tax is due and payable on or before the due date of the original return the entity is required to file, without regard to any extension of time for filing the return, for the taxable year of the extension. For taxable years beginning on or after January 1, 2022, and before January 1, 2026, different filing and payment due dates apply.

Partners, shareholders, or members who consented to have their pro rata share or distributive share of income included in the calculation of the elective tax are allowed a nonrefundable credit in an amount equal to the elective tax paid on their behalf. Any unused credit may be carried forward for up to five years. For an individual who is a nonresident or part-year resident, the credit will be allowed in its entirety, i.e., the individual does not have to prorate the credit based on the ratio of the individual’s taxable income to the individual’s total taxable income.

Main Street Small Business Tax Credit 

The budget bill expands and revises the Main Street Small Business Tax Credit, which is a credit against California’s personal and corporate income taxes for taxable years beginning in 2020 or sales and use taxes for reporting periods commencing on January 1, 2021, and until April 30, 2026, as specified, for qualified small business employers that received a tentative credit reservation in an amount equal to $1,000 for each net increase in qualified employees from the California Department of Tax and Fee Administration, which could allocate on a first-come, first-served basis up to cumulatively $100 million in credits but not more than $100,000 to any qualified small business employer.

Homeless Hiring Credit

The budget allows a credit under the personal income and corporation tax laws for each taxable year beginning on or after January 1, 2022, and before January 1, 2027, to a qualified taxpayer that employs an eligible individual during the taxable year in an amount between $2,500 and $10,000 per eligible individual, not to exceed $30,000 per taxpayer per taxable year, depending on the number of hours worked by the eligible individual and subject to specified conditions and limitations.

Credit for Rehabilitating Historic Structures

The budget extends by one year the taxable years for which the credit under the personal income and corporation tax laws for rehabilitating certified historic structures may be claimed, moving the credit from taxable years ending before January 1, 2026, to taxable years ending before January 1, 2027.

California Competes Tax Credit

The budget increases from $180 million to $290 million the amount of credits the California Competes Tax Credit Committee may allocate under the personal income and corporation tax laws for fiscal year 2021–2022.

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