The pass-through entity elective tax is a state-level option that lets a partnership, S-corporation, or LLC taxed as one of those pay state income tax at the business level instead of leaving the entire bill on its owners’ personal returns. The point is federal. When the entity pays the state tax, that payment counts as a business expense, which reduces the income flowing through to owners on their federal K-1s. Because it’s a business deduction rather than a personal one, it isn’t subject to the individual cap on state and local tax deductions. More than 35 states offer some version of the election, and the IRS confirmed the approach in Notice 2020-75.1Internal Revenue Service. Notice 2020-75
Why the Election Exists
Partnerships and S-corporations don’t pay federal income tax themselves. Each owner reports a share of the business income on a personal return and pays tax on it there. Before 2018, owners could deduct the full amount of state income tax paid on that income when they figured their federal bill. The Tax Cuts and Jobs Act of 2017 changed that by capping the individual state and local tax (SALT) deduction at $10,000. Owners of profitable pass-throughs in higher-tax states lost the ability to deduct tens of thousands of dollars in state tax.
States responded by creating an elective tax at the entity level. If the business pays the state tax, the payment is deductible as a business expense in computing federal taxable income before that income flows through. The owner still owes federal tax on the business income, but on a smaller amount, because the state tax has already reduced it. The IRS blessed this treatment in Notice 2020-75.
How the Deduction Flows Through
A short example makes the mechanics clear. A partnership earns $500,000 and elects to pay $40,000 in state income tax at the entity level. That $40,000 reduces the partnership’s federal taxable income to $460,000, and $460,000 is what flows to owners on their K-1s. Each owner reports a share of $460,000 on the federal return, not $500,000.
Without the election, the full $500,000 would flow through, and each owner would pay their share of the $40,000 in state tax on a personal return. Under the SALT cap, only $10,000 of that personal state tax would be deductible federally; the other $30,000 produces no federal benefit. The election recovers that lost deduction. For an owner in the 37% federal bracket, the $30,000 gap translates to roughly $11,100 in real federal savings.
Every state that offers the election also gives participating owners a way to avoid being taxed twice on the same income at the state level. Most provide a dollar-for-dollar credit on the owner’s personal state return equal to their share of the entity-level tax. Some states make the credit refundable, so any excess comes back as a refund. Others make it nonrefundable, meaning it can zero out state tax owed but won’t generate a refund on its own. The distinction matters most when an owner’s personal state tax liability is small relative to their share of the entity’s PTE payment.
Who Qualifies
Eligibility generally reaches S-corporations and partnerships, including LLCs that have elected to be taxed as one or the other. The entity must file a separate federal return as a partnership or S-corporation. Single-member LLCs treated as disregarded entities don’t qualify, because there is no separate entity-level return on which to report the tax.
Owner eligibility is where things get particular. Most states limit participation to individuals, estates, and certain trusts such as grantor trusts and electing small business trusts. C-corporation owners are typically excluded from participating. An S-corporation with only individual shareholders has an easy path. A partnership that has another partnership as a partner runs into rules that vary widely by state: some allow the upper-tier entity to participate with credits flowing up the chain, some require a separate election at each level, and some exclude tiered structures unless the income can be traced to an individual. Publicly traded partnerships are universally excluded.
How the Tax Is Calculated
The entity totals the shares of state-source income belonging to owners who consent to the election. If some owners opt out where the state allows partial participation, their income is excluded. The entity then applies the state’s PTE tax rate to that total.
Rates differ. Some states use a flat percentage on all qualified income. Some use graduated brackets that rise with the entity’s qualifying income. A few simply apply the state’s top individual rate. Two identical businesses in different states can face meaningfully different PTE bills, and the federal savings will vary with them.
The income on each K-1 has to line up with the entity’s state PTE calculation. Mismatches between federal K-1s and state PTE filings are a common audit trigger. The entity also has to track each owner’s allocated share of the payment, because that share is what the owner claims as a credit on the personal state return.
Making the Election and Paying the Tax
The election is made when the entity files its annual state return. For calendar-year partnerships and S-corporations, the federal return is due March 15, and most states tie the PTE election deadline to that same date.2Internal Revenue Service. Starting or Ending a Business 3 The election is generally irrevocable for the year it covers. Once made, the entity and all consenting owners are locked in.
Undoing an election after the fact is very hard. States that offer any relief usually limit it to genuine clerical mistakes like an accidental submission. If the entity passed PTE credits through to owners, voluntarily paid the liability, or documented the election in corporate minutes, most states treat those as evidence the election was intentional and refuse to reverse it. Run the numbers first, and make sure every participating owner understands the consequences before filing.
Most states require estimated payments during the year rather than a single payment at filing. A common structure calls for a payment by June 15 of the election year, with the balance due at filing. The mid-year installment is often the greater of a fixed minimum or a percentage of the prior year’s PTE tax. Missing or underpaying it doesn’t necessarily void the election, but the consequences vary: some states shrink the credit available to owners, others charge underpayment interest similar to individual estimated tax penalties.
What Changed for 2026
The $10,000 SALT cap was set to expire after 2025. The One Big Beautiful Bill Act extended a version of the cap while raising the ceiling to roughly $40,000 for 2026, with inflation adjustments in later years. Fewer owners will now bump against the limit, which reduces but doesn’t eliminate the value of the election.
The bigger question going into 2026 was whether Congress would treat PTE payments as “substitute payments” subject to the individual cap, which would have gutted the workaround. Earlier drafts included that language. The final bill did not. Entity-level PTE payments remain fully deductible as business expenses regardless of the individual cap’s size, and owners of specified service businesses like law and accounting firms keep the benefit as well, despite earlier proposals to exclude them.
The calculation has shifted, though. An owner who used to exceed the $10,000 cap by $50,000 might now exceed a $40,000 cap by only $20,000, so the election saves less than it did. An owner whose total state and local taxes fall below the new cap may get no federal benefit at all. Running the numbers each year before electing matters more now than under the flat $10,000 cap.
Multi-State and Nonresident Owners
Businesses operating in more than one state face the most involved planning. An entity may need to make separate elections in each state where it has income, and rules for sourcing income, applying rates, and allocating credits differ by jurisdiction. Paying PTE tax in a state doesn’t always eliminate the entity’s obligation to withhold on nonresident owners’ shares of income there.
For an owner living in one state whose entity pays PTE tax in another, the home state’s treatment of the credit is the key. Most states let residents claim a credit for income taxes paid to other states, and many extend that credit to cover an owner’s share of PTE taxes paid by the entity elsewhere. The owner has to document the share of PTE tax and the income sourced to the other state, even without filing a return there personally. Without that documentation, the home-state credit can be denied.
Owners in states with no personal income tax get no state-side credit from the election, because there’s no personal state tax to offset. The federal deduction still applies through the reduced K-1 income. But if the federal savings are modest, the compliance work of electing may not be worth it.