The pass-through entity tax (PTET) is a way for owners of pass-through entities—partnerships, limited liability companies, S corporations—to gain benefit from the state and local taxes paid without having to itemize and then apply the state and local tax (SALT) cap. All of this may sound confusing. Let me sort things out.
A little history
The Tax Cuts and Jobs Act of 2017 imposed a dollar limit on the deduction for state and local taxes (SALT). The limit is $10,000 whether married or single ($5,000 for married persons filing separate returns). The SALT cap runs through 2025 unless Congress changes it. Efforts to do so have failed each year since 2017, so it’s likely that the cap won’t disappear until 2026.
Rise of the workaround
States have sought ways to enable their residents to get around the SALT cap. Early efforts using charitable contributions failed.
Then a pass-through entity tax (PTET) was enacted, and the IRS said it was okay. The PTET is an entity-level tax on pass-through entities that is taken into account in figure the owners’ share of income passed through to them. In effect, the entity is factoring in the tax that owners would owe on their share of pass-through income. Owners get the benefit on their state income tax returns so they have less to claim on their federal returns. This arrangement successfully avoids the SALT cap with respect to taxes that would otherwise be paid on their distributive share.
Today, 36 states and New York City have a PTET; a bill is pending in one new state (Pennsylvania). The AICPA has a map showing these states, as well as those that don’t. Remember, 9 states have no owner-level personal income tax on pass-through income.
What a PTET means to you
If you have a sole proprietorship or are one-member LLC (a disregarded entity), you cannot benefit from a PTET. State income taxes paid on your net earnings from self-employment—your profits—are deductible only if you itemize and then are subject to the SALT cap.
If you have an interest in a partnership, multi-member LLC, or S corporation, check the PTET rules for your location. They vary considerably by location and are subject to change. Here are some considerations.
If you are a one-member LLC and elect to be treated as an S corporation, then you can avail yourself of PTET rules if there are any in your locality.
Is the PTET automatic. No. An annual election is required to apply the PTET. It was mandatory in Connecticut through 2023, but became optional (elective) in 2024. The election must be made by a set date; this varies considerably. For example, Arizona’s election is due by the due date of the business return (including extensions) (typically March 15); owners must be given 60 days’ notice of the election’s availability. California has a June 15 deadline for making a payment so an election can be made (see below). Virginia allows a retroactive election back to 2021, but only if a 2021 PTET return is filed by September 16, 2024.
When are payments due. The PTET may require an entity to make a payment to the state related to what the entity takes into account in determining distributive shares to owners. In California, it is the greater of $1,000 or one-half of the total California PTET for the prior year. The payment is due by June 15 of the current year and is required to enable the PTET election (although a pending bill would allow an election even if a payment has not been made). In other states, there’s quarterly estimated tax payments for PTETs.
How is the PTET benefit put into effect? In some states, owners of a PTE reduce their adjusted gross income from the entity. In others, electing owners take a credit for their share of PTE’s tax to offset their state income tax.
Final thought
The PTET is something every owner of a pass-through entity needs to discuss with their CPA or other tax pro. The PTET may affect not only their state and federal taxes, but also their balance sheet.
Additional blogs concerning pass-through entities have been published here.
