For U.S. business owners facing the SALT deduction cap, PTET offers a state-by-state, elective path to shift tax from individuals to the business while preserving a federal deduction.
What PTET is (and what it is not)
PTET stands for Pass-Through Entity Tax. It is a state-created election that lets certain pass-through entities—most often partnerships and S corporations—pay state income tax at the entity level. Owners then generally receive a state tax credit for their share of the PTET paid.
Think of it like moving a charge from your personal tab to the business tab. The bill is still paid to the same state; the key difference is where the deduction shows up on the federal return.
PTET is also not an off-the-books “loophole.” States enacted these laws deliberately in response to federal changes, and the IRS publicly accepted the basic structure.
Why PTET exists: the $10,000 SALT cap
Back in 2017, the Tax Cuts and Jobs Act (TCJA) capped the individual State and Local Tax (SALT) deduction at $10,000 per year. That cap hits many high-income owners hard, especially in high-tax states.
- Pass-through income is taxed on the owner’s personal return.
- When an owner pays, for example, $40,000 or $80,000 of state income tax personally, only $10,000 may be deductible federally if they itemize.
- The remainder becomes a lost federal deduction.
PTET exists because the SALT cap applies to individual itemized deductions, not to ordinary business deductions taken at the entity level.
The IRS stance that made PTET workable
The turning point was IRS Notice 2020-75, issued November 9, 2020. In that notice, the Internal Revenue Service (IRS) said it would treat qualifying entity-level state and local taxes imposed on pass-through entities as deductible in computing the entity’s non-separately stated taxable income.
In plain terms, a properly structured PTET payment can be deducted federally at the business level, rather than being trapped under the individual SALT cap.
You can read the notice on IRS.gov: IRS Notice 2020-75
How PTET works, step by step
Most PTET systems follow this pattern:
- Election (opt-in)
– The entity chooses PTET for that tax year, if the state offers it.
– Many states require a fresh election each year.
2. Entity pays the state tax
– The pass-through calculates PTET based on state rules and pays the tax to the state.
3. Federal entity-level deduction
– The PTET payment is treated as a deductible expense on the entity’s federal return.
4. Reduced income to owners
– Because the entity deducted the PTET, the income that flows to owners on their K-1 is lower.
5. Owners claim a state tax credit
– The state gives owners a state tax credit for their share of PTET paid.
– That credit offsets the owners’ personal state income tax tied to the pass-through income.
When the system works as intended, owners avoid double taxation and may preserve a federal deduction that would otherwise be limited by the SALT cap.
Comparison: traditional pass-through taxation vs PTET
| Particulars | Without PTET | With PTET |
|---|---|---|
| Who pays | Individual owner | Business entity |
| Where SALT appears federally | Schedule A, capped at $10,000 | Entity-level deduction (not under the individual SALT cap) |
| Federal deduction | Limited to $10,000 | Typically the full PTET amount may be deducted federally |
| Cash flow | Owners pay large personal estimates | Entity pays; may simplify owner estimated payments |
| Compliance | Lower | Moderate (election, tracking credits, estimates) |
A numerical example of potential federal savings
Assume one owner is allocated $500,000 of pass-through profit and the owner’s state tax is $45,000.
Without PTET
– The owner pays the $45,000 personally.
– Federal itemized SALT deduction is capped at $10,000.
– $35,000 of state tax produces no federal deduction.
With PTET
– The entity elects PTET and pays $45,000 to the state.
– The entity deducts that payment federally, so only $455,000 flows through to the owner.
– The owner receives a state tax credit for their share of PTET.
What is the federal value of the restored deduction? It depends on the owner’s bracket and other facts. As a simple illustration, if the owner is in a 37% federal bracket, an extra $35,000 deduction may reduce federal tax by about $12,950 (35,000 × 0.37). Results can differ based on limitations, other deductions, and state rules.
Who tends to benefit most
PTET often helps owners who meet several of these conditions:
- High-income pass-through owners whose state tax is well above $10,000
- Owners in high-tax states such as California, New York, and New Jersey
- Partners in professional firms (law, consulting, medical) with steady profits
- Businesses with predictable income, since PTET often requires estimated payments
PTET is frequently most valuable when the owner would otherwise be stuck with a large “dead” SALT amount that cannot be deducted federally.
✅ Model PTET results for each state and owner scenario before electing; seek professional tax advice
Cautions and risk points to consider
PTET is not automatic. Common issues that can reduce the benefit or create surprises include:
- Volatile income
- If profits swing down, the entity may overpay PTET. That can be painful in a state with non-refundable credits.
- Multi-state residency or multi-state filings
- Owners living in one state while earning income in another can face credit limits or timing mismatches.
- Credit type matters
- A refundable credit is not the same as a non-refundable credit. The difference can materially change cash outcomes.
- Standard deduction impact
- If an owner takes the standard deduction, the personal SALT cap may not be binding. PTET may still help, but the comparison requires careful calculation.
- S corporation wages vs K-1 income
- PTET typically applies to pass-through income, not W-2 wages. Owners with a large wage component may see less benefit.
- Future law changes
- PTET was built in response to the TCJA SALT cap. Any federal changes could reshape or nullify the value.
State-by-state differences (illustrative examples)
PTET is a state policy choice, so rules differ across availability, rates, elections, deadlines, and how credits are delivered to owners. Many programs took effect for tax years starting on or after January 1, 2021, though details vary.
| State | Election mechanics | Rate | Credit type |
|---|---|---|---|
| California | Elective, with timing rules tied to payments and the return | 9.3% | Credit to owners (details depend on year/filing posture) |
| New York | Annual election; commonly tied to a specific state deadline | Varies by taxable income base | Credit to owners |
| New Jersey | Elective PTET regime with entity payment and owner-level relief | Varies | Credit to owners |
| Illinois | Elective entity-level tax | 4.95% | Credit to owners |
| Iowa | Elective regime with state-specific computations | Varies | Credit to owners |
Use this table as a starting point, not a filing checklist. Election timing and credit treatment are where many real-world problems occur.
Compliance: where PTET succeeds or fails
Good PTET results usually come from clean execution:
- Confirm the entity and owners are eligible in each state.
- Make the election correctly, and repeat it annually if required.
- Pay estimates on time, and reconcile on the return.
- Track each owner’s share and confirm the state tax credit is claimed correctly.
⚠️ Election deadlines are hard and usually annual; improper timing can cost credits or invalidate the election for the year
Missteps can be costly because some states treat elections as irrevocable for the year after a certain point. That can lock in an election even if profits drop or ownership changes.
PTET is a legislatively sanctioned workaround to the SALT cap. Used carefully, it can shift state tax to the entity level and preserve federal deductibility that individuals may otherwise lose.
PTET is a tax policy topic with state-specific rules; consult qualified tax professionals for state-by-state guidance.
This article does not constitute legal or tax advice; results vary by state and ownership structure.
PTET serves as a state-level election allowing partnerships and S corporations to pay state taxes directly. This maneuver bypasses the federal $10,000 SALT deduction limit imposed on individuals. By deducting these taxes at the business level, owners reduce their federal taxable income. However, success depends on strict adherence to state-specific deadlines, election rules, and understanding the difference between refundable and non-refundable tax credits.
