3 Key Changes to California’s PTE Tax Election Under SB 132

Effective January 1, 2026, California is updating its Passthrough Entity Elective Tax (PTE) program under Senate Bill 132 (SB 132). These changes aim to expand access, streamline eligibility, and fix long-standing technical gaps in the program.

What Is the PTE Elective Tax?

California’s Passthrough Entity Elective Tax regime was originally enacted as part of AB 150 in response to the federal cap on state and local tax (SALT) deductions under the 2017 Tax Cuts and Jobs Act. The PTE program allows qualifying S corporations, partnerships, and LLCs treated as partnerships to pay tax at the entity level, thereby generating a federal deduction that bypassed the individual $10,000 SALT cap.

However, beginning in 2026, the SALT deduction cap increases to $40,000 under the One Big Beautiful Bill (OBBB). This change significantly reduces the benefit of the PTE election for many California business owners, particularly those with under $500,000 of adjusted gross income. For higher-income filers, the $40,000 cap phases back down to $10,000, preserving some planning value.

Owners of the entity then claim a corresponding credit on their California income tax return, effectively preserving the full deductibility of state taxes for federal purposes. Since its inception, the program has undergone several legislative revisions to expand eligibility and address administrative complexities.

3 Key Changes Effective in 2026

1. Election Available Through 2031

SB 132 extends the availability of California’s PTE election for an additional five years. Qualified passthrough entities, including S corporations, partnerships, and certain LLCs, may now elect into the program for taxable years 2026 through 2031. The election remains contingent on the continued existence of the federal SALT deduction limitation under IRC §164(b).

If Congress repeals the SALT limitation, California’s PTE program would also terminate in the same year. However, existing unused PTE credits from prior years would still carry forward for up to five years.

While the SALT cap is currently set to expire after 2025, its fate will likely be decided during major federal tax negotiations in late 2025, when Congress revisits key provisions of the 2017 Tax Cuts and Jobs Act. Until then, the extended PTE election remains in place, but businesses should be aware that its continued relevance depends on how federal tax policy evolves this year.

2. Late or Insufficient Prepayments No Longer Disqualify the Election

Under prior law, a PTE had to make a prepayment by June 15 of the taxable year to be eligible for the election. The prepayment had to equal the greater of:

• $1,000, or
• 50% of the prior year’s PTE tax liability.

Failure to make the full payment by June 15 (even by $1.00) disqualified the entity from making the election.

SB 132 eliminates this disqualification for tax years 2026 through 2031. Entities may now make the election even if the June 15 prepayment was late or underpaid. However, there is a penalty for late or insufficient payments: the owner’s PTE tax credit will be reduced by 12.5% of the amount underpaid as of June 15. This operates as a penalty imposed directly on the owner’s personal credit, not the entity’s tax liability.

Example:
An entity underpays its June 15, 2026, prepayment by $20,000. Under SB 132, the individual partners or shareholders will each see their PTE credit reduced by $2,500 (12.5% of $20,000), split among the owners based on their allocable share.

This relief does not apply for the tax year 2025. Entities that missed or underpaid their June 15, 2025, prepayment remain ineligible to elect in for 2025.

3. Clarification for Fiscal Year Entities

SB 132 clarifies that owners of fiscal-year passthrough entities with tax years beginning in 2025 but ending before January 1, 2026, should claim the PTE credit on their 2026 California individual income tax returns. This ensures consistent treatment for entities with non-calendar fiscal years.

What Parts of California’s Passthrough Entity Tax Stay the Same in 2026?

• The elective tax rate remains 9.3% on qualified net income.
• Owners eligible to claim the credit continue to include individuals, trusts, estates, and certain disregarded single-member LLCs.
• The PTE election remains optional and must be affirmed each tax year.

The Outlook for California’s PTE Regime

SB 132 marks a significant improvement to California’s PTE tax regime. It adds flexibility for taxpayers, mitigates harsh prepayment penalties, and extends the federal SALT workaround window through 2031—assuming no federal repeal. California business owners should start evaluating 2026 eligibility and prepayment strategy now to ensure they remain positioned to benefit.

The future of the PTE program will ultimately depend on how Congress addresses the federal SALT deduction cap during tax negotiations in late 2025. While SB 132 provides welcome clarity at the state level, passthrough entities should be prepared to adapt if the federal landscape shifts.

Additionally, the increase in the SALT deduction cap to $40,000 starting in 2026 may render the PTE election less valuable for many clients. For joint filers with AGI below $500,000, the expanded deduction may already absorb most state tax liability—diminishing the need for entity-level workarounds. As AGI rises above $500,000, the cap phases back down to $10,000, which may justify continued use of the PTE for those taxpayers.

If you’re unsure how these changes affect your business or if you need help planning for 2026, speak with a qualified California corporate tax attorney to evaluate your options and ensure compliance with both state and federal law.