Tips for a new tax year: the Passthrough entity elective tax

With filing season around the corner and a new year starting, here are some considerations regarding the passthrough entity elective tax and corresponding credit.

Making the election

If the entity chooses to make the passthrough entity tax election, there are a variety of factors to weigh when determining how and when the election should be made and the tax paid.

Also consider if the passthrough entity owner will be moving outside of California or anticipates a drop in income, because they may lose out on being able to take the credit.

Another question is: Will the owner be able to use up any credit carryovers? Also consider the interplay with other credits, such as the Other State Tax Credit.

For S corporations in which only some of the shareholders consent to have the tax paid on their behalf, the IRS hasn’t addressed whether the tax can be allocated only to those shareholders who consent, and based only on their share of the tax actually paid. This also affects S corporations that have nonresident shareholders whose share of the tax is based only on their California-source income.

Also, regarding making timely payments, remember that late or underpayments of the June 15 prepayment will result in an inability to make the election for that taxable year.

Passthrough Entity Elective Tax Credit issues

When the passthrough entity elective tax was first enacted, many tax professionals asked whether the corresponding credit could be treated as an estimated tax payment by the passthrough entity’s owners. The FTB has been clear that the credit is not an estimated tax payment.

However, it can be subtracted from the taxpayer’s estimated tax liability in determining the amount of estimated taxes due. But because credits can’t be applied against the mental health services tax, they can’t be subtracted from the mental health services tax liability when calculating the taxpayer’s estimated taxes due.

Unused amounts of credits originally claimed prior to January 1, 2026, can be carried forward for five years, even after the credit is expired. Carryovers are claimed on a first-in, first-out basis. However, a deceased taxpayer’s unused credit cannot be claimed by the taxpayer’s estate. Any of the taxpayer’s credit carryover remaining after the taxpayer’s final return is filed is lost.

Erroneous payments can be transferred

If a taxpayer erroneously applied passthrough entity tax payments to another tax owed by the entity, the FTB now has a process for transferring the misapplied payment so the taxpayer can avoid penalties.

A request to move payments related to an estimate payment, LLC or S corporation tax, or LLC fee should be submitted in writing. The request needs to be signed by an officer or owner of the entity, or a representative with a valid POA on file. The request also has to include acknowledgment that reapplying the payment to another liability could result in penalties and interest in the tax year where the payment was originally applied.

These requests can be submitted securely through a MyFTB account. Tax professionals may also contact the Tax Practitioner Hotline and speak with a representative to adjust the payment, but a written request is still required.