PTET Election and the SALT Cap Workaround

A pass through entity tax election lets an S corporation or partnership pay state income tax at the entity level, where it is fully deductible as a business expense, instead of passing it to owners where the SALT cap limits the deduction. The IRS blessed the approach in Notice 2020-75. More than 35 states now offer some version, and for a profitable pass through owner it is often the single largest federal deduction available with no change to operations.

The Problem PTET Solves

The 2017 tax act capped the state and local tax deduction on individual returns at $10,000. The One Big Beautiful Bill Act raised the cap to $40,000 beginning in 2025, with a phasedown for taxpayers above roughly $500,000 of modified AGI that pushes high earners back toward the $10,000 floor, and a scheduled reversion later in the decade.

For a business owner in a state with a 6 to 10 percent income tax, state tax on business income can be tens or hundreds of thousands of dollars. Under the cap, most of it is simply not deductible.

PTET changes where the tax is paid. There is no SALT cap on business deductions, so state income tax paid by the entity reduces the federal income that flows through on the K-1.

How It Works in Practice

The entity elects into the state's PTET regime, generally annually and often with an early deadline.
The entity pays state income tax on the owners' distributive shares of income.
That payment is deducted on the federal return as an ordinary and necessary business expense, reducing federal taxable income flowing to owners.
Owners claim a state credit or income exclusion so the income is not taxed twice at the state level.

The Math on a Real Example

	Without PTET	With PTET
S corp income	$1,000,000	$1,000,000
State tax at 7%	$70,000 paid personally	$70,000 paid by entity
Federal K-1 income	$1,000,000	$930,000
Federal SALT deduction	Capped, largely lost	n/a, already deducted
Federal tax at 37%	$370,000	$344,100
Federal savings		$25,900

The savings equal the state tax multiplied by the federal marginal rate. Simple, and it repeats every year.

Who Benefits Most

Owners of S corporations and partnerships with meaningful profit
Taxpayers in states with high income tax rates
High earners already past the SALT cap phasedown
Owners who itemize, and even many who do not, since the deduction is above the line at the entity

Who does not benefit: single member LLCs and sole proprietors filing on Schedule C, since there is no entity to make the election. That is one more reason entity choice matters. See S corp vs LLC and when to convert an LLC to an S corp.

The Traps

Deadlines are unforgiving. Many states require the election, or a first estimated payment, before the tax year ends or very early in the year. Miss it and you wait a full year. This is the most common way the benefit is lost.

Cash timing matters. The deduction generally lands when the entity actually pays. A cash basis entity that elects but does not pay by December 31 may not deduct until the following year.

Resident credits vary. If you live in one state and the entity pays PTET in another, your home state may or may not give you credit for the entity level tax. In some pairings this creates genuine double taxation. Multi state owners need the analysis before electing. See multi state tax planning.

It is not always all or nothing. Some states let individual owners opt in or out, others bind every owner. In a partnership with mixed residency or tax exempt partners, an election that helps one partner can hurt another.

Basis and distributions. PTET paid by the entity reduces the cash available to distribute and affects owner basis. For S corps, watch the interaction with shareholder basis.

It reduces QBI. The entity level deduction lowers qualified business income, which can slightly reduce a Section 199A deduction. The net is still strongly positive, but the modeling should account for it. See our QBI guide.

PTET and Reasonable Compensation

PTET generally applies to the pass through income, not to W-2 wages an S corp owner pays themselves. Since reasonable compensation must still be paid, salary dollars stay outside the PTET benefit. This slightly changes the usual salary versus distribution calculus: distributions now carry an additional federal benefit through PTET, which argues for keeping compensation at a defensible level rather than an inflated one.

What to Do Before Year End

Confirm your state has a PTET regime and identify the election deadline
Project entity taxable income for the year
Make the election and fund the payment before December 31 if the state requires payment for the deduction
Coordinate owner level estimated payments downward to avoid overpaying twice
Verify resident state credit treatment for any nonresident owners

PTET is one of the highest return, lowest complexity items in business owner planning. It requires no restructuring, no new entity, and no change in how the business operates. It just requires someone to file the election on time.

Frequently Asked Questions

What is a PTET election?

A pass through entity tax election allows an S corporation or partnership to pay state income tax at the entity level rather than passing the liability to owners individually. Because business level state taxes are not subject to the individual SALT deduction cap, the payment is fully deductible on the federal return, reducing the income reported on each owner's K-1. Owners then receive a state credit or exclusion so the income is not taxed twice by the state.

Is the PTET workaround allowed by the IRS?

Yes. In Notice 2020-75, the IRS confirmed that state and local income taxes imposed on and paid by a partnership or S corporation are deductible by the entity in computing its nonseparately stated income, and are not subject to the individual SALT limitation. More than 35 states have since enacted pass through entity tax regimes in reliance on that guidance.

How much does a PTET election save?

The federal savings roughly equal the state tax paid multiplied by the owner's federal marginal rate. An entity paying $70,000 of state tax for an owner in the 37 percent bracket saves about $25,900 of federal tax per year. The exact benefit depends on state rate, entity income, the owner's bracket, and any reduction in the Section 199A qualified business income deduction.

Who cannot use a PTET election?

Sole proprietors filing on Schedule C and single member LLCs treated as disregarded entities generally cannot, because there is no partnership or S corporation to make the election. C corporations do not need it, since they already deduct state tax at the entity level. Owners in states without a pass through entity tax regime also have no election available.

When is the deadline to make a PTET election?

Deadlines vary significantly by state. Many require the election or a first estimated payment before the close of the tax year, and some require it as early as the first quarter. Because the deduction typically requires the entity to actually pay the tax within the year, missing the payment date can cost the full year's benefit. Confirm your specific state's deadline well before December.

Does PTET affect my QBI deduction?

Yes, modestly. The entity level state tax deduction reduces qualified business income, which reduces the Section 199A deduction calculated on that income. The federal savings from the PTET deduction generally far exceed the small reduction in the QBI deduction, but the two effects should be modeled together rather than viewed in isolation.

PTET: The Pass Through Entity Tax Election That Works Around the SALT Cap