California amends PTE owner resident credit legislation


On Sept. 28, 2022, California Governor Gavin Newsom signed Senate Bill 851 (S.B. 851), making technical corrections to the state’s pass-through entity (PTE) tax law.1 The legislation enables California resident PTE owners to compute their other state tax credit without needing to make a downward adjustment to their “net tax” for other state tax credit calculation purposes, to the extent their net tax is decreased by the PTE tax credit allowed to an owner of an entity electing to pay the California PTE tax.






In July 2021, California enacted the Small Business Relief Act (SBRA), creating its PTE tax regime under which qualified entities may make an annual election to pay tax at the entity level on qualified net income at a 9.3% tax rate for the 2021–2025 tax years.2 Once the election is made, a PTE owner that is a “qualified taxpayer” is allowed an income tax credit against their California personal income tax liability based on 9.3% of the owner’s income that was included in the “qualified net income” of the electing PTE.3 To the extent unused by the PTE owner in the year of generation, any excess PTE credit may be carried forward for up to five years.4


Enacted in Feb. 2022, Senate Bill 113 (S.B. 113) amended the SBRA in several important respects.5 Of particular relevance, S.B. 113 amended California’s credit ordering rules such that, for the 2022–2025 tax years, the PTE tax credit is taken in into account after any other state tax credits allowed under California law.6 The amendment was borne out of concerns that, if the PTE tax credit allowed under the SBRA were applied before any credits for income taxes paid to other states, the other state tax credits would automatically expire because they cannot be carried over pursuant to California law. 


Notwithstanding the changes to credit ordering made by S.B. 113, the California Franchise Tax Board (FTB) had suggested a restrictive interpretation to the computation of the other state tax credit when claimed by a resident who also receives a PTE tax credit in the same year. In the FTB’s view, both before and after S.B. 113, the amount of the other state tax credit is calculated as the lesser of:


  • California tax liability * (double taxed income / California adjusted gross income (AGI)); or
  • Other state tax liability * (double taxed income / other state’s AGI).7

Under the FTB’s interpretation, when computing the other state tax credit, the calculation of California tax liability would be reduced by the amount of all other credits, including the PTE tax credit. The FTB publicly stated that this interpretation follows “because the OSTC cannot be given for a tax liability that is satisfied by other credits.”8 As a result, the California PTE tax paid and associated PTE tax credit of the qualified taxpayer owner would in theory reduce the California tax liability used for purposes of computing the allowable resident credit for other state taxes. This result essentially eliminated amounts paid through the PTE tax from the calculation of the resident’s credit for other state taxes paid, thereby reducing (or eliminating) the amount of other state tax credit available to a resident owner of a PTE that had contemporaneously made a PTE tax election under the SBRA in the same tax year.




Senate Bill 851


To reconcile the apparent legislative drafting issue and FTB policy, S.B. 851 amends the SBRA to provide that PTE owners calculate their other state tax credit by adding to their “net tax” the amount of their California PTE tax credit, which is equal to the owner’s pro rata share of income tax paid by the PTE that elected to pay tax at the entity level.9 This technical correction applies to the 2022–2025 tax years, which under S.B. 113 are the years in which the PTE tax credit is taken in into account after any other state tax credits.10






The legislative change to California’s other state tax credit computation was widely supported by both the state legislature and the Governor after several multistate public accounting firms, along with the California Society of Certified Public Accountants, submitted a letter to lawmakers explaining that their inability to fully utilize the resident credit for other state taxes was not intended by the legislature when it passed S.B. 113. In a signing statement accompanying S.B. 851, Governor Newsom noted that the legislation was necessary so that the FTB could implement the California PTE tax regime “in a manner that is consistent with previous legislative action.”11 This latest in a series of legislative corrections to California’s SBRA illustrates the ongoing practical difficulties of crafting a new PTE tax regime, and implementing targeted legislative changes intended to amend California’s credit ordering rules to benefit resident PTE owners.


The technical corrections made by S.B. 851 are welcomed by California resident owners of PTEs that have (or plan to) elect into the SBRA’s PTE tax regime. Without the legislative change, PTE owners could have potentially been limited in their ability to claim the other state tax credit beginning in 2022 despite the legislature’s efforts to better enable residents to claim the other state tax credit in the 2022–2025 tax years. In counting the PTE tax credit amount as part of the owner’s California tax liability for purposes of the resident credit calculation, the correction is designed to place resident PTE owners in the same position they would have been if they had paid PTE taxes directly at the individual level.



1 Ch. 705 (S.B. 851), Laws 2022.
2 Ch. 82 (A.B. 150), Laws 2021, enacted July 16, 2021, adding Cal. Rev. & Tax Code § 19900(a)(1).
3 Cal. Rev. & Tax Code § 17052.10(a).
4 Cal. Rev. & Tax Code § 17052.10(c).
5 Ch. 3 (S.B. 113), Laws 2022, enacted Feb. 9, 2022.
6 Cal. Rev. & Tax Code § 17039(a)(7).
7 See Senate Bill (SB) 113 Credit Ordering Rules, Tax News, California Franchise Tax Board, June 2022,
9 S.B. 851, § 1, amending Cal. Rev. & Tax. Code § 17052.10(e)(1).
10 S.B. 851, § 1, amending Cal. Rev. & Tax. Code § 17052.10(e)(2).
11 Senate Bill 851 Signing Statement, Office of California Governor Gavin Newsom, Sep. 28, 2022.





Dana Lance

Dana Lance is the Tax Practice Leader for the Greater Bay Area and the SALT Practice Leader for the West Region. Dana is based in San Jose, California.

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