Let’s be honest, the 2017 Tax Cuts and Jobs Act (TCJA) threw a lot of business owners a curveball. A big one. The $10,000 cap on state and local tax (SALT) deductions hit owners of pass-through entities—like S corporations, partnerships, and LLCs—especially hard. It felt like getting taxed twice, honestly.
But here’s the deal: states didn’t just sit back. They got creative. And that’s where Pass-Through Entity Taxes (PTET) come in—a clever, state-by-state workaround that’s become a crucial tax planning tool. It sounds complex, but stick with me. We’re going to break it down into plain English.
The SALT Cap Problem: Why Everyone Started Looking for a Workaround
Before the cap, if you owned a business in a high-tax state, you could deduct all your state income taxes on your federal return. It was a relief valve. The $10,000 limit? Well, for many, it slammed that valve shut. A partner in a successful firm could suddenly see a six-figure state tax bill with no federal deduction. Ouch.
The pain point was real. It created a genuine incentive for business owners to even consider relocating. States, fearing lost revenue, needed a fix. And they found one in the IRS’s own rules.
PTET Explained: The Engine of the Workaround
In simple terms, a PTET shifts the tax burden. Instead of the business owner paying state tax personally (and hitting the SALT cap), the business itself pays the tax at the entity level. This is the core mechanism of the SALT cap workaround.
Think of it like this: you’re at a group dinner with a spending limit per person. The PTET lets the restaurant (the entity) pay the tax on the meal, so it never shows up on your individual bill. The total cost might be similar, but the structure changes everything for the IRS.
How the Pass-Through Entity Tax Actually Works: A Step-by-Step
It’s not magic, it’s procedure. Here’s the typical flow:
- Election: The entity elects to pay the state PTET. This is usually an annual, irrevocable choice. You can’t be wishy-washy about it.
- Payment: The business calculates and pays the state income tax directly. This reduces the distributable income that flows to you, the owner.
- Federal Deduction: Here’s the win. The entity claims this tax payment as a business expense on its federal return. It’s fully deductible—bypassing the individual $10,000 SALT cap entirely.
- Owner Credit: The state gives you, the owner, a credit or a exclusion for your share of the tax paid. This prevents double taxation at the state level. You still report income, but you get a credit for tax already paid.
The net effect? Your overall state tax liability might be a wash, but your federal taxable income drops. That’s the whole ball game.
Key Considerations and, Honestly, Complications
Sure, it sounds great. But PTET regimes are a patchwork quilt. No two states are exactly alike, and that’s where the devil is. You know how it goes.
First, not every state offers a PTET election. Most high-tax states do (like New York, California, New Jersey, Illinois), but you must check your specific state’s rules. It’s a moving target, with new states adopting laws each year.
Second, the eligibility rules vary wildly. Some states allow all pass-through entities. Others exclude certain entity types or only allow it for individuals (not trusts or estates) as owners. The definition of “resident” vs. “non-resident” owner also gets tricky.
Let’s look at a quick comparison of a few state approaches:
| State | PTET Rate Structure | Key Nuance |
| New York | Graduated rates up to 10.9% | Elective; covers both resident & non-resident owners. |
| California | 9.3% flat rate | Elective; tax is deductible for CA purposes too. |
| Illinois | 4.95% flat rate | Replaces personal income tax for owners; not an add-on. |
| New Jersey | Graduated rates | Entity makes a “partner tax” payment on behalf of owners. |
And then there’s the timing of payments. Some states require estimated PTET payments. Missing an election deadline is a silent killer—you’re locked out for the year.
The Non-Resident Owner Headache
This is a big one. If your business operates in multiple states, PTET can simplify things… or make them a nightmare. Many states designed their PTET to also solve the non-resident withholding problem.
By having the entity pay the tax, it often satisfies the non-resident owner’s filing obligation in that state. That’s a huge administrative win. But you have to make sure the credit flows correctly on your home state return. It’s intricate, and getting it wrong means you might pay tax twice. A conversation with a pro is non-negotiable here.
Is a PTET Election Right for Your Business? Asking the Hard Questions
It’s not an automatic yes. The benefit depends on your specific numbers—your income level, your state’s tax rates, the mix of owners. You need to run the math. Sometimes, the cost of the entity-level payment (which reduces income for other potential deductions) outweighs the federal benefit.
Ask yourself and your advisor:
- Do we operate in a state with an elective PTET?
- Are our owners primarily individuals (not corporations) subject to high state taxes?
- Will the federal tax savings exceed any potential complications or minor state tax quirks?
- What are the administrative burdens for our accounting team?
For many, the savings are substantial. For others, it’s a break-even with added complexity. You have to model it.
The Future of SALT Cap Workarounds: A Temporary Fix?
That’s the million-dollar question. The federal SALT cap is currently set to expire after 2025. But will it? Politics being what they are, it could be extended, modified, or even repealed. The IRS has, so far, blessed these workarounds through Notice 2020-75, but the landscape could shift.
What does that mean for you? It means PTET planning is a year-by-year, agile strategy. It’s not a “set it and forget it” part of your business. It requires attention. The trend, for now, is toward more states adopting these laws and more businesses using them. It’s a testament to the ingenuity—and frustration—built into our tax code.
In the end, the story of PTETs is a story of adaptation. It’s about businesses and states navigating a federal rule that, frankly, didn’t consider their reality. It’s a powerful tool, but one that demands respect for its complexity. The key takeaway? Don’t go it alone. The potential savings are too significant to leave on the table, but the pitfalls are just as real. Understanding the conversation is the first step to making it work for you.
