Articles · Basics · State and Local Tax (SALT)
Pass-Through Entity Tax (PTET): The SALT Cap Workaround
Individuals face a federal cap on their state and local tax deduction under Section 164. Many states responded by letting partnerships and S corporations elect to pay state tax at the entity level.
How it works
The entity pays state income tax on behalf of its owners and deducts the payment in calculating federal income. The IRS confirmed this treatment in Notice 2020-75. Owners then receive a reduced federal income allocation, along with a state credit or exclusion, depending on the state.
An example
Suppose a partnership earns $1 million and elects a 5% state tax, paying $50,000. Federal income passed to owners falls to $950,000. At a 35% rate, that can save $17,500 in federal tax, if the owners could not otherwise deduct the state tax.
What to consider
Rules vary widely by state, including election deadlines, who can participate, and how nonresident owners are treated. Elections can affect resident credits in other states, self-employment income, and the qualified business income deduction.
Timing also matters, because the entity generally must pay in the tax year to deduct it, depending on its accounting method. Model the outcome for each owner before electing.
Key takeaways
- The entity deducts the state tax federally.
- Owners receive a state credit or exclusion.
- Run the numbers owner by owner.
For general education only, not tax advice. Tax law changes often, so confirm current rules and amounts with primary sources.