Since 2018, the federal deduction for state and local taxes (SALT) has been capped. Recent law raised the cap for many households, but it phases back down for higher earners, many of whom are still limited to about $10,000. For business owners in high-tax states, a pass-through entity (PTE) tax election can restore much of the lost deduction.
How a PTE election works
- Your S corp or partnership elects to pay state income tax at the business level on the owners’ share of income.
- The business deducts that tax on its federal return, which lowers the income passed through to you on your K-1. The SALT cap does not apply to this business-level deduction.
- You receive a credit on your state return for the tax the business paid, so you are not taxed twice by the state.
The IRS confirmed in 2020 that these entity-level taxes are deductible by the business, and more than 30 states now offer a version.
A simple example
An S corp owner with $500,000 of business income in a state with a 9.3% rate would pay about $46,500 of state tax on that income. If the business pays it through a PTE election and the owner is in the 35% federal bracket, the federal savings can be roughly $16,000, before other effects.
Who benefits most
- Owners of S corps and partnerships in states with an income tax
- Higher earners whose SALT deduction is still limited
- Owners whose state tax far exceeds the cap
What to watch for
- Deadlines and prepayments: some states require an election or an early payment by a set date, and missing it can cost you the benefit for that year.
- All-owner effects: the election affects every owner, so partners need to agree.
- QBI: the deduction lowers business income, which can slightly reduce the QBI deduction.
- Multi-state owners: credits may not carry over neatly to another state where you live.
We look at PTE elections with every business owner as part of tax planning.