Pass-Through Entity Tax (PTET): The SALT-Cap Workaround Explained

The pass-through entity tax (PTET) is an optional, entity-level state income tax that partnerships, S corporations, and multi-member LLCs can elect to pay instead of pushing the state tax obligation through to individual owners. Because the entity pays and deducts the tax as a business expense on its federal return, the payment sidesteps the individual $40,400 SALT cap entirely. More than 36 states and localities have enacted PTET regimes, and the structure survived the One Big Beautiful Bill Act (OBBBA) of 2025 with no restrictions.

What Is the Pass-Through Entity Tax Election?

Under the federal tax code, partnerships and S corporations are “flow-through” vehicles. The entity itself generally pays no federal income tax; income flows to owners, who report it on their individual returns. State income tax on that income has traditionally been paid at the owner level as well, making it subject to the personal state and local tax (SALT) deduction cap.

The PTET election flips that mechanism. When a pass-through entity elects in under its state’s PTET regime, the entity pays state income tax directly. That payment is a fully deductible business expense under federal tax law, reducing the entity’s income before it flows to owners. Owners then receive a credit on their personal state returns equal to their share of the PTET paid, so the state tax burden does not double up.

The IRS blessed this structure in IRS Notice 2020-75 (November 2020), which clarified that “specified income tax payments” made by partnerships and S corporations at the entity level are deductible in computing the entity’s non-separately stated income. That guidance pre-dates TCJA’s $10,000 SALT cap and has not been reversed by any subsequent legislation, including OBBBA.

Why the SALT Cap Makes PTET Valuable

A Quick History of the SALT Cap

The Tax Cuts and Jobs Act of 2017 (TCJA) capped the individual SALT deduction at $10,000 ($5,000 for married filing separately). For owners of profitable pass-through businesses in high-tax states, that cap was immediately painful: state income taxes on six- or seven-figure pass-through income can easily reach $50,000 to $200,000 or more, yet only $10,000 of that was federally deductible.

What OBBBA Changed

The One Big Beautiful Bill Act, signed July 4, 2025, raised the individual SALT cap significantly. For 2026, the cap is $40,400 for single filers and married filing jointly (indexed annually by 1% through 2029). A phase-out applies for taxpayers with modified adjusted gross income above $505,000 ($252,500 for married filing separately). Above that threshold, the cap is reduced by 30 cents for every dollar of MAGI, but it never falls below $10,000. The higher cap is temporary and is scheduled to revert to $10,000 in 2030.

Even with the higher cap, the math still favors PTET for most profitable pass-through owners. An S-corp owner with $800,000 in pass-through income in a state with a 5% flat rate will owe roughly $40,000 in state tax on that income alone. The individual SALT deduction covers that almost exactly for 2026, but not at all once the phase-out bites in above the $505,000 MAGI threshold. For owners above that threshold, or for entities in states with higher rates, PTET continues to deliver substantial savings.

OBBBA Did Not Restrict PTET

Earlier draft versions of OBBBA included provisions that would have barred specified service trades or businesses (SSTBs) and investment activities from using PTET. Those restrictions were stripped before the final bill passed. The enacted OBBBA does not limit PTET availability by entity type or activity, leaving it fully open to professional service firms, investment partnerships, and every other pass-through structure.

How the PTET Election Works: Mechanics Step by Step

1. The Election Is Made at the Entity Level

Every eligible owner must participate once the entity elects. A single partner or shareholder cannot opt out while others opt in. The election is typically annual and irrevocable for the year once certain deadlines pass (usually tied to a required estimated payment or a state-specific filing date).

2. The Entity Estimates and Pays the Tax During the Year

Most states require quarterly estimated PTET payments tied to the entity’s projected income. Missing these payments can result in penalties, and in some states, missing an estimated payment deadline forfeits the deduction for that year entirely. Getting the election filed and estimates on calendar early is essential.

3. The Federal Deduction Flows Through to Owners

Because the entity pays the state tax, it deducts the amount on its federal return before allocating income to owners. Each owner’s Schedule K-1 reflects a lower share of net income. That reduction passes through to the owner’s Form 1040, lowering federal taxable income automatically, with no itemized deduction required.

4. Owners Claim a State Credit

States that have enacted PTET regimes provide a corresponding owner-level credit on the personal return. The credit is generally dollar-for-dollar against the owner’s personal state income tax liability attributable to the pass-through income. The result: the owner’s total state tax burden is unchanged, but the federal deduction shifts from the capped individual SALT itemized deduction to an uncapped entity-level business expense.

Which Entities Are Eligible?

Most state PTET regimes follow a similar eligibility framework:

• Eligible: Partnerships (including multi-member LLCs taxed as partnerships) and S corporations.
• Not eligible: C corporations (which already pay entity-level state tax), single-member LLCs taxed as disregarded entities, and sole proprietorships.
• Trusts: Treatment varies by state; check the specific state statute.

Individual owners who are themselves pass-through entities (for example, a partnership that is a partner in another partnership) face additional complexity around credit mechanics that varies widely by state.

State-by-State Landscape in 2026

Over 36 jurisdictions had enacted PTET regimes as of mid-2026, including nearly every high-income-tax state. Rules differ substantially on several dimensions:

• Election timing. Some states require an annual opt-in before a specific date (often the first estimated payment due date). Others allow a late election or a retroactive election under certain conditions.
• Rate structure. Most states tax at the entity level using a rate tied to the top individual rate for that state. A handful use a flat rate separate from the individual rate.
• Credit mechanics. The vast majority provide a fully refundable credit to resident owners. Non-resident owner treatment and the mechanics for trusts or tiered pass-throughs vary.
• Sunset dates. Several state programs were set to expire. California extended its PTET program for five additional years. Illinois and Utah removed their sunset dates. Oregon extended to tax years beginning before January 1, 2028. Practitioners must verify current status for each relevant state before advising clients.

The New York State Department of Taxation provides one of the more detailed publicly available resources on state PTET mechanics at tax.ny.gov/bus/ptet/.

Quantifying the Benefit

To illustrate the value, consider a hypothetical S-corp with 2 equal shareholders, operating in a state with a 6% income tax rate on a net income of $1,000,000.

• Without PTET: Each owner receives $500,000 of pass-through income and pays $30,000 in state income tax personally. Each owner’s SALT deduction is capped, so much of that $30,000 provides no federal deduction given the phase-out at high MAGI levels. At a combined federal/state effective marginal rate of roughly 45%, the lost deduction costs each owner approximately $13,500, or $27,000 combined.
• With PTET: The entity pays $60,000 in state income tax, deducts it federally, and each owner’s K-1 income is reduced by $30,000. Each owner receives a $30,000 state credit, netting to zero additional state cost. The federal savings on the $60,000 deduction at a 37% top rate is approximately $22,200.

Note: These figures are illustrative estimates. Actual savings depend on each owner’s effective marginal rate, state credit mechanics, QBI deduction interaction, and other factors. The QBI deduction under Section 199A (made permanent by OBBBA at 20%) is calculated on the entity’s W-2 wages and qualified property, and a PTET payment reduces net income, which can reduce the QBI deduction base. A full analysis should account for this interaction.

Working with a tax advisor experienced in multi-state pass-through planning, like the team at Modus, is essential to quantify the net benefit accurately before electing.

Key Planning Considerations

Estimate the interaction with QBI. A PTET payment reduces net ordinary income flowing to owners, which lowers the QBI deduction base under Section 199A. For entities where the deduction is not already capped by the wage/property limitation, this can partially offset the federal benefit.

Watch deadlines closely. Election and estimated-payment deadlines vary by state and are frequently tied to the entity’s first quarter payment date. A missed deadline can forfeit the deduction for the entire year. Build PTET filing dates into your annual tax calendar at the start of each year.

Coordinate across states. Multi-state entities face complexity when the same income is sourced to multiple states with different PTET regimes, rates, and credit mechanisms. Some states do not allow a credit for PTET paid to another state, creating potential double-taxation risk that must be modeled.

Non-resident owners. Several states limit the PTET credit to resident owners or allocate credits based on in-state income. Non-resident partners and shareholders in high-income-tax states may not recover the full credit, altering the economics of the election.

Basis effects. Entity-level PTET payments reduce distributable income, which can affect an owner’s outside basis in the entity. Particularly in S corporations, basis tracking must be updated to reflect the PTET payment properly.

For businesses with complex ownership structures, PTET planning ties closely into broader business tax advisory work around entity structure, compensation strategy, and state nexus management.

Related reading: Economic Nexus for Sales Tax After Wayfair: What Businesses Must Know

Frequently Asked Questions

What is the pass-through entity tax (PTET)?

The PTET is an elective, entity-level state income tax available to partnerships, S corporations, and multi-member LLCs in states that have enacted a PTET regime. The entity pays the tax directly, deducts it as a business expense on its federal return, and individual owners receive a corresponding state tax credit. The structure bypasses the individual SALT deduction cap, allowing business owners to recover a federal deduction for state income taxes that would otherwise be limited or disallowed.

Who can benefit most from a PTET election?

Pass-through entity owners who face high state income tax on business income and whose personal SALT deduction is limited or phased out benefit most. Owners with modified AGI above $505,000 in 2026 face phase-outs of the new $40,400 SALT cap, making the PTET election particularly valuable. Profitable S-corps and partnerships in high-tax states such as California, New York, New Jersey, Minnesota, and Oregon are frequent candidates.

Did the One Big Beautiful Bill Act eliminate or restrict PTET elections?

No. Early draft versions of OBBBA included provisions that would have restricted PTET for specified service trades or businesses (SSTBs) and investment activities. Those provisions were removed before the bill was enacted. The final OBBBA, signed July 4, 2025, preserved PTET fully for all pass-through entity types, including professional service firms.

Does a PTET election affect the Section 199A qualified business income (QBI) deduction?

It can. Because the PTET payment is deducted at the entity level, it reduces the net ordinary income flowing to owners. That lower income figure is the starting point for the QBI deduction calculation under Section 199A. For entities where the 20% QBI deduction is not already limited by the wage and capital limitation, a PTET election may modestly reduce the QBI deduction benefit. The net outcome depends on each owner’s specific circumstances and should be modeled before electing.

Is the PTET election irrevocable?

In most states, the election is irrevocable for the year once the deadline passes, which is often tied to the entity’s first PTET estimated payment. Some states offer limited exceptions or late-election provisions. Practitioners should review the specific statute and any administrative guidance for each state before relying on revocability.

What records does an entity need to maintain for a PTET election?

The entity should document the election itself (typically an online filing or form), all estimated PTET payments with dates and amounts, the calculation of each owner’s credit amount, and how the entity-level deduction is reflected in the K-1 allocations. Basis schedules for S-corp shareholders must be updated to reflect the PTET payment. These records support both the federal deduction and the owner’s state credit, and they should be retained in the entity’s tax file for the standard statute of limitations period.