The pass-through entity tax is a SALT workaround that lets an S corporation or partnership pay state income tax at the business level, so the payment becomes an uncapped federal business deduction for the entity instead of a capped personal deduction for the owners. The IRS blessed the structure in Notice 2020-75, confirming that state income taxes paid by a partnership or S corporation are deductible in computing the entity’s income and are not subject to the individual SALT deduction limit for the owners.1IRS. Notice 2020-75 More than 36 states now offer some version of the election, and it continues to deliver real savings even after the 2025 changes to the federal SALT cap.
How the Workaround Actually Works
The Tax Cuts and Jobs Act of 2017 capped the individual state and local tax deduction at $10,000 per household. For owners in states with moderate or high income tax rates, a large slice of their state tax bill became non-deductible on the federal return. PTET sidesteps this by moving the payment from the individual to the entity.
The sequence is straightforward. The pass-through entity elects into the state’s PTET regime and pays state income tax directly on the portion of its income attributable to qualifying owners. Because the entity is the taxpayer, that payment is treated as an ordinary business expense, reducing the entity’s federal taxable income before anything flows through to the owners on Schedule K-1.1IRS. Notice 2020-75 The owners then receive a credit on their personal state returns equal to their share of the PTET paid, so the same income is not taxed twice at the state level.
A simple example. If a partnership earns $1 million and pays $90,000 in PTET, the partners collectively report $910,000 of federal income on their K-1s rather than $1 million. That $90,000 deduction is not subject to the individual SALT cap.1IRS. Notice 2020-75 On the state side, each partner claims a credit for their share of the tax the entity already paid. In most major states the credit is fully refundable, meaning any excess over the owner’s personal state liability comes back as a refund. A smaller number of states treat it as nonrefundable, allowing only a carryforward. That distinction matters when the PTET rate differs from an owner’s effective personal rate.
Is PTET Still Worth It After the 2025 SALT Cap Increase?
The One Big Beautiful Bill Act, signed in July 2025, raised the individual SALT deduction cap from $10,000 to $40,000 starting in 2025. For 2026, the cap ticks up 1 percent to $40,400, and the income threshold at which it begins phasing down rises to $505,000 of modified adjusted gross income. Above that threshold, the cap shrinks by 30 cents for every additional dollar of income, dropping back to $10,000 at roughly $606,000 of MAGI. From 2030 onward, the cap resets to $10,000 across the board.
For owners whose total state and local taxes stay under $40,400 and whose income stays below the phase-down threshold, the higher personal cap may be enough on its own. PTET still pays off in two situations.
- High earners above the phase-down. Once MAGI passes $505,000 in 2026, the personal SALT cap starts shrinking, and by $606,000 it is back to the pre-2025 $10,000. PTET bypasses that phase-down entirely because the deduction sits at the entity level.
- Owners in high-tax states. Even under the $40,400 cap, an owner in a state with a 9 or 10 percent top rate who also carries meaningful property taxes can blow through the limit quickly. Moving the state income tax portion to the entity frees up cap room for property taxes and other state levies on the personal return.
The 2025 law also added anti-avoidance provisions targeting SALT cap misuse. Entity-level state tax deductions for businesses were not eliminated, but how these provisions interact with existing PTET regimes is an area where guidance is still developing. It is worth confirming the current landscape with a tax advisor before each election year.
Which Entities Can Elect
PTET is available to entities whose income flows through to their owners rather than being taxed at the corporate level: S corporations and partnerships, including LLCs taxed as partnerships and limited liability partnerships. C corporations do not qualify because they already deduct state taxes at the entity level as a matter of course.
Eligibility depends on ownership structure as well as entity type. The election typically covers only the share of income belonging to owners who are individuals, estates, or certain trusts. If a partnership has a C corporation or a tax-exempt organization as a partner, the income allocated to that partner generally cannot be swept into the PTET calculation. States handle this differently, but the common thread is that only the income flowing to individual-type owners gets taxed under the election.
Tiered Structures Are a Trap
When one partnership owns a stake in another, things get harder. A lower-tier partnership can elect PTET on its own, and so can an upper-tier partnership that receives income from it. But the credit generated at the lower tier does not automatically flow through the upper-tier entity to its individual owners. Each entity in the chain that wants its owners to benefit needs to make its own separate election. Income allocated to a partner that is itself an entity, rather than an individual, generally cannot generate a PTET credit for that entity partner.
Most mistakes happen here. If a multi-tier structure incorrectly allocates PTET credits to an entity partner that is not an eligible credit recipient, no one in the chain can use them. The electing entity would have to amend to correct the allocation, and if it misses the window, the credits can be permanently lost.
Making the Election
The process varies by state, but every jurisdiction requires some combination of a formal election, consent from the owners, and timely payments.
Deadlines
States fall into two camps on timing. Most allow the entity to make the election on its timely filed tax return, including extensions, which effectively pushes the deadline out to the extended due date. A smaller group of states require a separate election filing earlier in the year. Some require the election to be filed online between January 1 and March 15 of the tax year itself, meaning you have to commit before you have a clear picture of the year’s income. Miss the deadline and you are locked out for that year in most states.
Owner Consent
Before filing, the entity needs authorization from its owners. State requirements range from unanimous consent of all qualifying owners to a simple majority vote. Your operating agreement or shareholder agreement may impose a stricter threshold. The election will need the entity’s EIN, the legal names and addresses of all participating owners, and their ownership percentages. Documenting the consent in writing protects against disputes later if an owner questions how the tax was allocated.
Irrevocability
Once made and the filing deadline passes, the election is irrevocable for that tax year. You cannot unwind it if the numbers turn out worse than expected. It also does not carry forward automatically. A fresh election is required for each tax year.
Multi-State Owners Need to Look Twice
Owners who live in one state and earn PTET-covered income in another face extra complexity. If your entity pays PTET to the state where it earns income, your home state may or may not grant a resident credit for that payment. Many states allow resident credits for PTET paid to other states, but they usually require the other state’s tax to be “substantially similar” to their own. If your home state does not recognize the other state’s PTET as a qualifying tax, you can end up paying tax on the same income in both states without a full offset.
Nonresident owners should also watch the filing mechanics. Some states let entities file composite returns on behalf of nonresidents, but claiming the PTET credit through a composite or group return is not always permitted. In those states, the nonresident has to file an individual return in the entity’s state to actually capture the credit. Skip that step and the entity paid the tax but the owner never gets the personal benefit.
Estimated Payments and Penalties
Most states require the electing entity to make quarterly estimated PTET payments, similar to individual estimated income tax. Common due dates fall around the 15th or 20th of March or April, June, September, and December, with the specific calendar varying by state. Some states require a double payment in the first or second quarter.
Underpayment penalties generally apply if the entity does not pay enough during the year. The typical safe harbor mirrors individual estimated tax rules: pay at least 90 percent of the current year’s PTET liability or 100 percent of the prior year’s. A few states waived underpayment penalties in the initial years of their PTET programs, but those grace periods are largely expiring.
Estimated PTET payments are separate from any individual estimated payments the owners might make. If the entity elects PTET, the owners typically do not need to make personal estimated payments on the income covered by the election. Income not covered by the election, such as income allocated to an ineligible partner, still requires the usual individual estimates.
Basis and Coordination
The PTET payment reduces each owner’s tax basis in the entity, and getting this wrong causes problems later. When the entity deducts the payment and reports lower income on the K-1s, each owner’s basis drops by their share of the tax paid. The state credit the owner receives is not an income item that increases basis; it simply offsets a personal tax liability. Owners already operating near the floor of their basis need to watch this carefully, because a PTET election that pushes K-1 income lower can limit their ability to deduct losses in the same year.
The entity’s tax preparer and each owner’s personal preparer have to coordinate. It is the only way to make sure the K-1 income, the PTET credit, and the personal return all line up. The entity should give each owner documentation showing the total PTET paid, that owner’s allocated share, and the credit amount to report. Errors on this front are among the most common triggers for state tax notices and adjustment letters.