What Is the Pass-Through Entity Tax (PTET) Election?

The Pass-Through Entity (PTE) Tax election is a state-level tax strategy designed to provide relief to certain business owners. It allows eligible businesses to manage state and local tax obligations differently, potentially offering federal tax benefits.

Understanding the Pass-Through Entity Tax Election

The Pass-Through Entity Tax (PTET) election allows certain businesses to pay state income taxes at the entity level rather than having owners pay individually. Its primary purpose is to address the federal State and Local Tax (SALT) deduction limitation. The Tax Cuts and Jobs Act of 2017 (TCJA) imposed a $10,000 cap on state and local taxes individuals could deduct on their federal income tax returns. This cap significantly impacted taxpayers in states with high income or property taxes.

A pass-through entity is a business structure where profits and losses are “passed through” directly to the owners’ personal income without being subject to corporate income tax at the entity level. Common examples include partnerships, S corporations, and many limited liability companies (LLCs) that elect to be taxed as partnerships or S corporations. Before the PTET, income from these entities was taxed solely on the owners’ individual returns.

The PTET emerged as a direct response to the federal SALT cap, offering a workaround that allows states to impose a tax at the entity level. This enables the entity to deduct state taxes paid, effectively bypassing the individual owner’s $10,000 federal SALT deduction limitation. The election is optional for eligible entities.

How the Election Works for Entities and Owners

When a pass-through entity makes a PTET election, the business itself, such as a partnership or S corporation, pays income tax directly to the state. This is a departure from the traditional pass-through model where the entity’s income is reported on the owners’ individual tax returns, and the owners pay the state income tax. The entity-level tax payment is generally deductible for federal income tax purposes. This deduction reduces the entity’s federal taxable income, which then flows through to the owners.

For the owners of the electing pass-through entity, the mechanism provides a significant benefit. After the entity pays the state income tax, the owners typically receive a corresponding tax credit on their individual state income tax returns. This credit offsets their personal state income tax liability for the portion of income that was already taxed at the entity level. The income is still reported on the owners’ individual returns, but the state tax liability associated with that income is effectively covered by the credit.

This process effectively mitigates the impact of the federal SALT cap. By converting a limited individual deduction into a fully deductible business expense at the entity level, the PTET provides a significant tax advantage.

State Specific Rules

The implementation of the Pass-Through Entity Tax (PTET) varies significantly among states. Approximately 36 states and New York City have enacted PTET election options.

States differ on which types of pass-through entities are eligible. Most states include partnerships and S corporations, but some extend eligibility to certain limited liability companies (LLCs) or have specific requirements for qualified owners. The method for calculating the PTET base income also varies. Some states may include all of the entity’s income, while others might limit it to income sourced within that state or only income attributable to resident owners.

The way the credit is applied at the individual owner level also varies. Credits can be either refundable, meaning any excess credit beyond the individual’s state tax liability is returned, or non-refundable, where unused credit can be carried forward to offset future state tax liabilities.

Election deadlines are another area of state-specific divergence. Some states require the election to be made by the original due date of the entity’s tax return, while others allow it to be made by the extended due date, or even retroactively for prior tax years. For instance, New York State and New York City generally require the election by March 15 of the tax year. The specific state tax rate applied to the electing entity’s income also differs. Consulting specific state tax guidance is important before making a PTET election.

Making the Election

The procedural steps for making a Pass-Through Entity Tax (PTET) election are specific to each state. The election is made by the pass-through entity itself, or an authorized representative, on behalf of its owners.

Common methods for making the election include checking a designated box on the state income tax return, filing a separate election form, or making an estimated tax payment. States often provide specific forms or schedules that must be completed to formally elect and report the PTET paid.

Deadlines typically align with the due date of the entity’s tax return, including any extensions. Some states may require an affirmative election by a certain date within the tax year, while others allow the election to be made when the tax return is filed. Entities making the election may also be required to make estimated tax payments throughout the year.

The ability to revoke a PTET election also varies by state. Some states permit revocation under specific conditions and within certain timeframes, while others may not allow revocation once the election is made for a tax year.