Pass-Through Entity Tax (PTET) Workarounds for SALT Cap: Saving on Personal State Taxes

The 2017 Tax Cuts and Jobs Act capped the State and Local Tax (SALT) deduction at $10,000 per year for federal tax purposes. For taxpayers in high-tax states, this was one of the most expensive changes in the law. A New York resident paying $40,000 in state income tax and $20,000 in property tax previously deducted the full $60,000 on their federal return. After the cap, only $10,000 of that deductibility remained — effectively raising their federal tax bill by the value of the lost deduction at their marginal rate.

In response, many states created Pass-Through Entity Tax (PTET) regimes that let pass-through businesses (partnerships, S corps, and LLCs taxed as either) pay state tax at the entity level and bypass the SALT cap for federal purposes. Individual owners still ultimately bear the economic cost of state tax, but the federal deduction is preserved by shifting who writes the check.

This is one of the most valuable tax planning moves available to business owners in high-tax states — and one of the most commonly overlooked. This article walks through how PTET works, which states have it, when the election makes sense, and the specific traps to avoid.

To appreciate the PTET solution, start with the problem it solves.

Before 2018: A pass-through business owner earns $500,000. State income tax (say, 8%) on that is $40,000. The owner pays personally (through state estimated taxes or at filing). On their federal Schedule A, they deduct $40,000 as state and local tax, reducing federal taxable income.

After 2018 SALT cap: Same scenario. The owner pays the same $40,000 in state tax. But their federal deduction for that state tax is capped at $10,000 (combined with property tax — so the state income tax deduction is often zero once property tax uses up the allowance). They've lost the federal benefit of $30,000+ in state tax payment.

At a 32-37% federal bracket, the lost deduction costs approximately $9,600-$14,800 per year for this example owner. Over 10 years, $100,000+ in incremental federal tax for the same state tax payment.

The PTET election fixes this by having the entity pay the state tax directly, deducting it at the entity level (where the SALT cap doesn't apply because it's a business expense, not an individual's state tax).

The structure, at a high level:

Without PTET: - Business entity earns income. Passes through to owner via K-1. - Owner personally pays state income tax on the pass-through income. - Owner's federal deduction for state tax is capped at $10,000.

With PTET: - Business entity elects to pay state tax at the entity level on its income. - The entity pays the state tax directly from business funds. - The entity deducts the state tax paid as a business expense on its federal return (not subject to the SALT cap because it's an entity-level business expense). - The state tax paid by the entity reduces the business income that passes through to the owner. - The owner receives a credit on their personal state return for the PTET paid by the entity (so they don't double-pay).

The economic outcome for the owner: same total state tax paid, but the federal deduction is preserved.

Worked example for a sole owner of an S corp in a state with a 7% PTET:

• S corp net income: $400,000
• PTET paid by entity: $28,000 (7% of $400,000)
• Federal deduction at entity level for PTET: $28,000
• K-1 income to owner: $372,000 (reduced by the PTET paid)
• Owner's federal tax base is $372,000 instead of $400,000
• Owner's state tax: $0 on pass-through income (PTET satisfied the obligation), or owner receives credit on personal state return for the PTET paid
• Federal tax savings at 32% bracket: $28,000 × 32% = $8,960

The owner has saved $8,960 in federal tax by making the PTET election. The state's take is the same. The federal government collects less. Win for the state's residents who own pass-through businesses; loss for the federal fisc.

The PTET landscape has expanded dramatically since 2021. Most states with meaningful income taxes have enacted some form of PTET. A partial snapshot:

• Many high-tax northeast states (New York, New Jersey, Connecticut, Massachusetts, Rhode Island)
• High-tax mid-Atlantic and South (Maryland, Virginia, Georgia, North Carolina, South Carolina)
• Much of the Midwest (Illinois, Michigan, Minnesota, Wisconsin, Ohio, Indiana)
• Several West Coast and mountain states (California, Oregon, Colorado, Arizona, New Mexico, Utah)
• Many other states with income tax

States without income tax (Texas, Florida, Tennessee, Washington, South Dakota, Nevada, Wyoming, Alaska) obviously have no PTET because there's no state income tax to shift. Owners in those states don't need PTET for state tax purposes (though they might interact with PTET rules when doing business in states that have them).

State-by-state details vary considerably:

Election timing. Some states require the PTET election to be made annually; others automatically elect for all eligible entities; others have opt-out structures.

Tax rate. Some states tax PTET at a flat rate; others use a graduated schedule or tie the rate to the highest marginal individual rate.

Credit mechanism. Some states give owners a full credit against their personal liability for the PTET paid; others have partial credit structures.

Estimated payments. Some states require quarterly PTET estimated payments; others annually.

Resident vs. nonresident treatment. States handle resident owners (full credit) vs. nonresident owners (varies, sometimes partial credit) differently.

Each state has its own specific rules. Consult with a CPA familiar with your state's specifics before electing.

The election is generally beneficial when:

The owner is in a high federal tax bracket. The federal deduction restoration is worth more at higher brackets. At 37% bracket, a $50,000 restored deduction is worth $18,500. At 22%, it's worth $11,000.

The state has meaningful income tax. Higher state tax = more state tax shifted to the entity = larger federal deduction restored.

The business has significant income. PTET is worth more on larger income.

Other SALT capped items are present. If the owner is already SALT-capped by property tax and other state tax, every additional dollar of state tax outside PTET is entirely lost for federal purposes.

The owner isn't close to AMT or other limitations. The PTET benefit can be reduced or eliminated by certain alternative minimum tax or deduction limitation rules; specific situations can limit the benefit.

The election tends to benefit most pass-through owners in states with meaningful income tax. For owners in low-tax states or owners with modest business income, the benefit may be smaller or negligible.

Several scenarios reduce or eliminate the benefit:

Low federal bracket. If the owner is in a 10-12% federal bracket, the deduction restoration is worth less.

Existing low income or losses. If the business has a loss or minimal income, PTET doesn't apply or isn't beneficial.

Owner is in a state without income tax. If you live in Texas and your business is in Texas, there's no PTET because there's no state tax. PTET may still be relevant if you have pass-through income from entities doing business in other states.

Potential complications with credits from other states. For multi-state businesses, credit coordination between states can get complicated.

State mechanics of the specific PTET. Some states' PTET implementations have complications that reduce the benefit — partial credits, limitations, or interaction with other credits.

A critical legal point: the IRS issued Notice 2020-75 confirming that PTET payments made by pass-through entities are deductible at the entity level for federal tax purposes. This was the green light that made PTET workable across states. Without the IRS acceptance, PTET payments could have been disallowed or treated as constructive payments by the owner (which would have hit the SALT cap).

Notice 2020-75's acceptance isn't absolute. It specifically requires that the PTET be imposed on the entity by state law and that the entity, not the owner, is legally liable for the tax. Some specific state implementations have nuances that could affect federal treatment. But broadly, PTET as implemented by most states works for federal tax purposes.

This legal foundation matters because it removes the "will the IRS disallow this?" risk that accompanied some earlier SALT workarounds.

The mechanics of electing PTET vary by state but typically involve:

Entity-level election. The election is made by the entity (the S corp or partnership), not by individual owners. For entities with multiple owners, there's usually a requirement that all owners (or a specified majority) consent to the election.

Timing. Most state elections must be made annually. Some are made on the entity's state tax return; others on a separate election form. Missing the election deadline for a year means losing the benefit for that year (though you can usually elect for the following year).

Estimated payments. The entity typically needs to make quarterly estimated PTET payments similar to an individual's estimated tax payments. Missing estimates can trigger penalties.

Coordination with owner's personal returns. Owners typically need to coordinate their personal state returns with the entity's PTET election — reporting the credit, adjusting the income base, or using specific forms. Tax software generally handles this, but custom situations may require attention.

Documentation. Keep documentation of the election, the tax paid, and the owner-level credit claimed. State audits can review PTET positions.

PTET mechanics differ slightly between partnerships and S corps in some states:

Partnerships: All partners usually need to consent to the election. The partnership pays tax on all partnership income subject to PTET. Some states have different treatment of general partners vs. limited partners, or resident vs. nonresident partners.

S corps: All shareholders typically need to consent (and S corps have single-class-of-stock rules that limit certain variations). The S corp pays tax on all S corp income; shareholders get credit proportionally.

For multi-owner entities where not all owners agree on the election, the structure can become complicated. Some states allow partial elections; others require unanimous consent.

Nonresident owner complications. If one owner lives in a different state than the entity's state, PTET may partially benefit them and partially not. Some states don't grant full credit to nonresident owners. Work through the math for mixed-state ownership groups.

Credit mechanics that reduce the benefit. Some states offer only a partial credit against the individual's liability, effectively double-taxing portion of the income. Understand your state's specific credit formula.

Interaction with state AMT or other special taxes. Some states have alternative minimum tax or special surtaxes that interact with PTET. The overall benefit can be reduced.

Late elections. Missing the election deadline for a year forfeits the benefit. Mark your calendar.

Coordination with non-PTET states. For businesses operating in multiple states where only some have PTET, careful coordination is needed to optimize across jurisdictions.

Cash flow timing at the entity level. The entity now has to fund state tax payments that were previously funded by the owner personally. For some businesses, this is a cash management consideration. The total cash outflow is the same; the timing and location shift.

PTET was enacted by states in response to the 2017 federal SALT cap. The SALT cap is scheduled to sunset after 2025 under current federal law. If the SALT cap actually sunsets (returning to uncapped state tax deductibility), the PTET workaround becomes unnecessary.

However:

• The SALT cap may be extended or made permanent by future legislation
• Even if the SALT cap sunsets, states may keep PTET as optional (it costs the state nothing to allow entities to pay tax at the entity level if the tax is equivalent)
• Planning requires watching legislative developments through 2025 and beyond

For now, PTET remains a valuable tool. Plan on it being available but stay aware of legislative changes.

To appreciate how significant this can be, consider a high-income owner in a high-tax state:

• State income tax on pass-through income: $50,000
• Federal bracket: 37%
• Without PTET: Lost federal deduction of ~$40,000 (assuming $10,000 SALT already used by property tax). Cost: $14,800 per year.
• With PTET: Federal deduction preserved. Same state tax paid, $14,800/year federal benefit.

Over 10 years, that's $148,000 in cumulative federal tax savings from a single election. For owners in the specific profile PTET was designed to help, this is one of the highest-value tax planning decisions available.

Many owners haven't elected PTET simply because they haven't heard about it, or their CPA hasn't proactively recommended it. If you're a pass-through owner in a state with PTET and you're not currently using it, asking your CPA specifically whether you should be electing PTET is worth the conversation.

The election is reversible for many states (you can change the election year-to-year). The cost of electing when it doesn't benefit you is typically minimal (slightly more complex entity return). The cost of not electing when it would benefit you is often thousands or tens of thousands of dollars per year. The asymmetry favors electing whenever the math looks favorable.