Pass-Through Entity Tax (PTET)

The pass-through entity tax is an elective state-level income tax paid by a partnership or S corporation on behalf of its owners, designed as a workaround to the federal cap on the individual deduction for state and local taxes. The mechanism is straightforward: the entity pays state income tax and deducts it as an ordinary business expense in computing federal taxable income, reducing the income flowing through to owners. Owners then receive a credit or income exclusion on their state returns for the tax the entity paid. Because the deduction occurs at the entity level, it is not subject to the individual SALT cap.

The approach was validated by IRS Notice 2020-75, which confirmed that specified income tax payments made by a pass-through entity are deductible in computing non-separately-stated income. Following that notice, the great majority of states with an income tax enacted PTET regimes.

Design details differ substantially and materially. States vary on whether the election is annual or binding for multiple years, when it must be made, whether it is made at the entity or owner level, whether all owners must consent, whether the tax base includes only resident owners' shares or all income, whether the corresponding owner benefit is a credit or an exclusion, and how the credit interacts with resident credits for taxes paid to other states. Estimated payment requirements are often earlier and less forgiving than ordinary state deadlines.

The One Big Beautiful Bill Act increased the individual SALT cap substantially beginning in 2025 with a phase-down for higher-income taxpayers, which changes but does not eliminate the PTET calculus. Election modeling by owner and by state remains a recurring annual engagement, because the right answer varies by owner residency and income profile.