PTE Tax Election: What It Is and How It Works

A Pass-Through Entity (PTE) tax election is an optional tax that certain businesses can pay at the entity level. This mechanism originated as a workaround to the federal State and Local Tax (SALT) deduction limitation created by the Tax Cuts and Jobs Act of 2017, which capped individual deductions at $10,000 per household. In response, many states enacted legislation allowing pass-through entities like partnerships and S corporations to pay state income tax on behalf of their owners.

By making this election, the business pays the state tax directly and deducts the full amount as a business expense on its federal tax return. This reduces the entity’s federal taxable income, which lowers the income that “passes through” to the owners, who then receive a credit or exclusion on their personal state tax returns.

Determining Eligibility and Suitability

To use a Pass-Through Entity (PTE) tax election, a business must meet its state’s eligibility criteria. Entities taxed as S corporations and partnerships, including many LLCs, are qualifying entities, though publicly traded partnerships are often excluded. The entity’s ownership is also a factor, as some states restrict the election to entities owned solely by individuals, estates, and certain trusts. The presence of a corporate or other ineligible partner could disqualify the entity.

A business should analyze if the election is financially advantageous for its owners. This includes reviewing owner consent requirements, which vary by jurisdiction. Some states may require consent from owners holding more than 50% of the entity, while others might need a different threshold or a specific action by a managing member. The election is binding on all owners, meaning individuals cannot opt out.

The residency status of the owners affects the suitability of the election. The benefits are most pronounced for owners who are residents of the state where the election is made. For non-resident owners, the advantages depend on whether their home state offers a credit for taxes paid to another state under a PTE regime. Modeling the tax outcomes for each owner is recommended to avoid negative consequences.

Calculating the Entity-Level Tax

The Pass-Through Entity (PTE) tax calculation starts with the tax base, which is the portion of the entity’s income subject to state tax. The tax base is the sum of each owner’s share of the entity’s income. For S corporations, this is the entity’s state-sourced income, while for partnerships, it may be a mix of state-sourced income for non-residents and total distributive income for residents. The income, gain, loss, or deduction items included are those that flow through to the owners on their federal Schedule K-1.

States may require adjustments to federal taxable income to determine the state-specific tax base. These modifications can include adding back certain federal deductions or subtracting state-exempt income. A business operating in multiple states must apportion its income according to each state’s rules to determine the income sourced to that jurisdiction.

Once the tax base is established, the entity applies the state’s designated PTE tax rate. This rate is often set to equal the highest marginal individual income tax rate in that state. For example, a state might apply a flat rate of 5% to the entity’s qualified net income. If an entity has $500,000 in qualified income in a state with a 5% PTE tax rate, the tax owed would be $25,000.

Making the Election and Submitting Payments

The process for making a PTE tax election is dictated by each state’s specific rules and deadlines. The election is made annually on a timely filed original tax return, often by checking a box on the standard partnership or S corporation return. Some states may require a separate election form. Elections are irrevocable for the tax year and cannot be made on an amended return.

Electing entities may need to make estimated tax payments throughout the year if the expected tax liability exceeds a state’s threshold, such as $500. These payments are due quarterly.

Payments are submitted electronically through a state’s online portal or via ACH credit, though some states permit payment by mail with a voucher. These PTE tax payments must be made separately from the entity’s other tax obligations.

Reporting for Pass-Through Owners

After a Pass-Through Entity (PTE) pays the tax, it claims a deduction for the state taxes paid on its federal income tax return. This reduces the net income of the business, lowering the taxable income reported to each owner on their federal Schedule K-1. This federal deduction is the mechanism that helps owners bypass the $10,000 SALT deduction limitation.

However, proposed legislation known as the One Big Beautiful Bill Act could disallow this federal deduction for certain “Specified Service Trades or Businesses.” This includes businesses in fields like law, health, and financial services.

Owners receive information about the PTE tax paid on their behalf on their state-level Schedule K-1. This document shows the owner’s share of the tax paid by the entity.

The owner claims a credit or an income exclusion on their personal state income tax return. This credit is equal to the owner’s share of the PTE tax paid and prevents their income from being taxed twice by the state. The owner will report this credit on their individual state tax form, often using a specific code to identify it as a PTE tax credit. Depending on state rules, any unused credit may be refundable or carried forward to future years.