The PTET workaround lets a partnership or S corporation pay state income tax at the entity level and deduct it as an ordinary business expense, so the tax never lands on the owner’s personal return and never counts against the federal SALT cap. IRS Notice 2020-75 blesses the approach as a safe harbor.1Internal Revenue Service. IRS Notice 2020-75 – Deductibility of Payments by Partnerships and S Corporations for Certain State and Local Income Taxes The One Big Beautiful Bill Act, signed on July 4, 2025, raised the individual SALT cap from $10,000 to $40,000 starting in 2025, which changes the math for middle-income owners.2U.S. Congress. H.R.1 – 119th Congress (2025-2026) But a steep income-based phaseout keeps the workaround valuable for higher earners.
How the Mechanics Work
Instead of individual owners paying state tax on their share of business income and claiming it as a personal itemized deduction (where the SALT cap bites), the business entity pays the state tax directly and treats it as a Section 162 trade or business expense.3Office of the Law Revision Counsel. 26 U.S. Code 162 – Trade or Business Expenses Notice 2020-75 confirms that these entity-level payments do not count toward any owner’s SALT deduction limit.
The arithmetic is simple. A partnership earns $500,000 and pays $40,000 in state income tax through a PTET election. That $40,000 reduces the entity’s taxable income to $460,000. Owners receive Schedule K-1s reflecting $460,000, not $500,000. The state tax has been fully deducted at the federal level, and none of it went through anyone’s personal SALT cap.
Two things have to be true for this to work. The state where the entity files has to have enacted its own PTET statute authorizing the entity-level election. More than 30 states have. And the entity has to actually make the election under that state’s rules and pay the tax on time. The federal notice provides the framework; without a state statute, the federal side has nothing to attach to.
Does the Workaround Still Matter After the 2025 SALT Cap Increase?
Under the OBBBA, the individual SALT deduction limit is $40,000 for 2025 and rises 1% annually through 2029, reaching $40,400 for 2026. Married taxpayers filing separately get half. After 2029, the cap reverts to $10,000 unless Congress acts again.
For a middle-income pass-through owner whose total state and local taxes fall below the new cap, the workaround adds complexity without saving money. The reason it still matters is the phaseout. Starting in 2025, the allowable SALT deduction is reduced by 30% of the amount by which a taxpayer’s modified adjusted gross income exceeds $500,000 for joint filers ($250,000 for separate filers), with those thresholds increasing 1% per year. A floor of $10,000 protects even the highest earners from losing the deduction entirely, but the erosion between the threshold and the floor is fast.
Take a married couple filing jointly with $800,000 in modified AGI and $50,000 in state income taxes flowing from their S corporation. Their MAGI exceeds the 2026 phaseout threshold of roughly $505,000 by $295,000. The 30% reduction wipes out $88,500, more than the entire cap, so they land at the $10,000 floor. A PTET election lets the S corporation deduct the full $50,000 at the entity level and skip the phaseout entirely. That’s a $40,000 difference in deductible state taxes. At a 37% marginal federal rate, roughly $14,800 in federal tax savings.
The workaround also frees up the personal cap for other state and local taxes. An owner whose property taxes alone approach $40,000 can shift the state income tax burden to the entity level and use the personal cap on the property tax bill.
Which Entities Qualify
Only partnerships and S corporations can make the election, because those are the entities whose income passes through to owners. Multi-member LLCs taxed as partnerships qualify, since the IRS treats them as partnerships for federal purposes. Sole proprietors filing Schedule C don’t qualify: there’s no separate legal entity to make the payment. C corporations don’t need the workaround because they already deduct state income taxes at the corporate level.
Each state’s PTET statute sets its own rules on eligible entity types, tax rates, and how the corresponding credit flows back to owners. Confirm your entity type qualifies under the specific state statute before electing in.
How PTET Payments Interact With Other Federal Rules
The 199A Deduction Shrinks With It
This is where owners most often overstate the benefit. The Section 199A qualified business income deduction, which rises from 20% to 23% starting in 2026, is calculated on the entity’s income after deductions, including the PTET payment. When the entity deducts state tax at the entity level, the QBI flowing to owners drops by the same amount. On a $500,000 income business paying $50,000 through PTET, QBI falls to $450,000. At 23%, that’s roughly $11,500 less in QBI deduction ($103,500 instead of $115,000). The PTET usually still produces a net benefit, but any analysis that ignores the 199A offset is overstating what the election actually saves.
AMT Isn’t a Problem Here
State and local taxes aren’t deductible against alternative minimum taxable income. Because the PTET is deducted at the entity level as a business expense, the state tax reduces income before it ever reaches the owner’s personal return. The AMT add-back for state taxes doesn’t apply to the PTET amount.
Refundable State Credits Raise a Federal Question
Most states give owners a credit on their personal state returns for taxes paid through the PTET, to prevent double taxation at the state level. Whether that credit is refundable or nonrefundable varies. If a refundable credit exceeds the owner’s state tax liability, the excess could be treated as taxable income under the federal tax-benefit rule. The IRS has not issued definitive guidance on this point for PTET credits specifically, so owners receiving refundable credits should evaluate the federal implications with a tax professional.
Timing the Payment
When the entity pays determines the year of the federal deduction, and the rule depends on accounting method.
Cash-basis entities deduct in the year they pay. A check mailed December 28, 2026 lands on the 2026 return. Accrual-basis entities normally can’t deduct a tax until economic performance occurs, which for taxes means when the tax is paid. But the recurring-item exception lets them deduct in the year the tax is incurred if payment is made within 8½ months after the close of that tax year.4Internal Revenue Service. Publication 538, Accounting Periods and Methods For a calendar-year entity, a 2026 PTET liability is deductible on the 2026 return if paid by September 15, 2027.
State-level election deadlines are a separate matter. They vary from as early as March 15 of the tax year to as late as the extended return filing deadline in September, and they can change from year to year. Missing the state deadline means the entity cannot elect for that year, regardless of when payment is made. Check the state’s current deadline every year.
Where the Workaround Can Backfire
The election isn’t automatic value. Several situations can shrink or eliminate the expected benefit:
- Owner mismatch. Not every partner or shareholder benefits equally. If some owners fall below the SALT cap phaseout, the election forces them into an entity-level structure they don’t need. For S corporations, making the election when owners have unequal tax situations can raise concerns about the one-class-of-stock requirement.
- Trapped credits. Some states provide only partial credits to owners, or limit when the credit can be used. If a nonrefundable credit exceeds the owner’s state liability, the excess is lost.
- Multi-state complications. Owners who live in a different state than where the entity operates face the question of whether their home state will honor the PTET credit. Not all states treat entity-level payments as creditable income taxes for the resident credit, and the owner can end up paying state tax twice on the same income.
- Compliance cost. The election requires additional state filings, potentially separate entity-level estimated payments, and coordination between the entity return and every owner’s personal return. Entities with owners in multiple states carry a real administrative burden.
- QBI reduction. The entity-level deduction lowers qualified business income and shrinks the Section 199A deduction, as discussed above.
Model each owner’s situation before electing. AGI, other SALT deductions, state credit treatment, and 199A eligibility all matter. What saves one partner money can cost another.
Filing the Election on Federal and State Returns
The process starts with the state. The entity files the required election form through the state’s tax portal or by paper and makes the associated payment. Most states require estimated payments throughout the year.
On the federal return, partnerships report the PTET payment on Form 1065, Line 14 (Taxes and Licenses), which reduces ordinary business income.5Internal Revenue Service. Instructions for Form 1065 S corporations report it on the corresponding line of Form 1120-S. The entity then issues Schedule K-1s reflecting the reduced income. Owners use those K-1s on their personal federal returns and separately claim the state tax credit on their individual state returns to avoid double taxation at the state level.
Keep the state election form, proof of payment, and the calculations allocating the PTET among owners. The tax preparer should verify that the K-1s, the federal return, and the state filings all reconcile. Discrepancies between what the business deducts and what owners report are the kind of mismatch that generates automated IRS notices.