The SALT Cap Workaround for Pass-Through Entities

The Tax Cuts and Jobs Act of 2017 (TCJA) placed a $10,000 limit on the amount of state and local taxes (SALT) that could be deducted on individual federal income tax returns. This SALT deduction includes property taxes and either state income or sales taxes. Before the TCJA, the deduction for these taxes was unlimited, providing a tax benefit for those in high-tax states.

The implementation of this cap meant that many individuals could no longer deduct the full amount of their state and local taxes, leading to a higher federal tax liability. In response, many states developed a workaround for certain business owners that allows state taxes to be paid in a way that bypasses the individual SALT cap.

Understanding the Pass-Through Entity Tax Workaround

The workaround for the federal SALT deduction cap is known as the Pass-Through Entity Tax (PTET). This strategy shifts the payment of state income tax from the individual owners of a business to the business entity itself. First, a pass-through entity, such as an S corporation or a partnership, voluntarily elects to be taxed at the entity level for state income tax purposes. The business then pays the state income tax directly to the state on its profits.

This payment is recorded as a business expense on the entity’s federal tax return, making it fully deductible as the $10,000 cap does not apply to taxes paid at the entity level. To prevent the owners from being taxed twice on the same income, the state provides a corresponding tax credit or deduction on the owner’s personal state income tax return to offset the tax already paid by the entity. The result is that the state tax is effectively paid and deducted at the business level, preserving the full value of the deduction lost at the individual level.

Consider a partnership with two equal partners in a state with a 6% income tax. If the partnership earns $500,000, each partner’s share is $250,000, resulting in a state tax liability of $15,000 each. Without the PTET, each partner could only deduct $10,000 of this on their federal return. By making a PTET election, the partnership pays the $30,000 ($500,000 x 6%) directly to the state. This $30,000 is fully deducted on the partnership’s federal return, and each partner receives a $15,000 credit on their state return.

Eligibility and State-Specific Adoption

Eligibility for the PTET election is limited to specific types of business structures. The most common eligible entities are S corporations and partnerships, which includes multi-member limited liability companies (LLCs) that have elected to be taxed as a partnership. These business types are known as pass-through entities because their income, losses, and deductions are passed through to their owners.

Conversely, certain business structures are typically excluded from making a PTET election. Sole proprietorships and single-member LLCs that are treated as disregarded entities for tax purposes usually cannot participate.

A majority of states with an income tax have enacted some form of PTET legislation. As of early 2025, at least 36 states have adopted a PTET regime. This widespread adoption demonstrates a clear trend among states to provide relief to their resident business owners from the federal limitation.

While the core concept of the PTET is similar across states, the specific rules can vary. In most states, the election to pay tax at the entity level is voluntary, allowing businesses to decide annually whether it is beneficial. However, in a few states, the PTET may be mandatory for certain types of entities. Business owners must consult their specific state’s department of revenue for the exact rules governing the election in their jurisdiction.

Information and Calculations for the PTET Election

Before deciding to make a PTET election, business owners must analyze several factors to determine if it is the right choice for their specific situation. A primary consideration is the residency of the entity’s owners, as the benefits of a PTET can differ for resident and non-resident owners. The analysis should confirm that the federal tax savings from the entity-level deduction outweigh any potential state-level costs or administrative complexities.

Another step is calculating the PTET tax base, which is the amount of income the entity-level tax will be applied to. States have adopted various methods for determining this base. A common approach is to include all of the entity’s distributive income, while other states may limit the tax base to only the income that is sourced to that specific state.

To complete the election, businesses will need to gather specific information for each owner:

• Full name
• Taxpayer identification number (such as a Social Security Number or Employer Identification Number)
• Their ownership percentage in the entity
• The residency status of each owner

The necessary state-specific PTET election form can be found on the website of the state’s department of revenue.

The Election and Tax Filing Process

Once the decision to elect has been made and the necessary calculations are complete, the business must formally make the election with the state. The method for submitting the election form varies by state. Common procedures include filing the form electronically through the state’s online tax portal, submitting it as part of the entity’s annual income tax return, or filing it by a separate, specified deadline.

Making the PTET election also comes with the responsibility of paying the associated tax. Many states require businesses to make estimated tax payments throughout the year, similar to how individuals pay estimated taxes. These payments are typically due on a quarterly basis, and businesses should adhere to their state’s specific payment schedule to avoid penalties.

For federal purposes, the entity deducts the PTET payment as a state tax expense on its return, such as on Form 1065 for partnerships or Form 1120-S for S corporations. This is where the federal tax benefit is realized.