A Pass-Through Entity Tax (PTET) is a state-level income tax elected by partnerships, S corporations, and LLCs taxed as pass-throughs — paid at the entity level rather than by individual owners — specifically designed to work around the $10,000 federal SALT deduction cap for individual taxpayers. The IRS blessed this strategy in Notice 2020-75 (irs.gov/pub/irs-drop/n-20-75.pdf) on November 9, 2020. See irs.gov and your state's revenue department for applicable PTET rules.
The Tax Cuts and Jobs Act of 2017 (TCJA) capped the federal itemized deduction for state and local taxes (SALT) at $10,000 per year for individual taxpayers — a severe restriction for high-income earners in high-tax states (California, New York, New Jersey, Connecticut, Illinois). Many pass-through business owners who previously deducted unlimited state income tax on their individual returns lost a substantial federal deduction overnight. The PTET mechanism: A PTET elects the state income tax up to the entity level. The entity pays the state tax on behalf of its owners; the entity deducts the state tax payment as a business expense on the federal return (under IRC § 164(a), business taxes are deductible without the $10,000 SALT cap). The individual owners receive a state tax credit equal to their share of the PTET paid, offsetting their personal state income tax liability. Net effect: federal deductibility of state income taxes is restored for pass-through owners, despite the TCJA SALT cap. IRS Notice 2020-75: IRS Notice 2020-75 (November 9, 2020, available at irs.gov/pub/irs-drop/n-20-75.pdf) confirmed that specified income tax payments made by a partnership or S corporation are deductible business expenses, not SALT-capped personal deductions — the critical legal blessing that made PTETs viable at scale. Since the Notice, nearly all 50 states have enacted or are considering PTET legislation. State-by-state variation: PTET rules vary significantly by state: (1) elective vs. mandatory; (2) which entity types qualify (partnerships only, S corps only, or both); (3) calculation method (flat rate, composite rate, or graduated); (4) whether nonresident owners are included; (5) refundability of excess credits; and (6) withholding requirements. High-impact states: California (election due by original return due date), New York (annual election by March 15), New Jersey (elective), Connecticut (mandatory). Consult your state's revenue department. Quantifying the benefit: For a California S corporation with $2M in net income and two 50/50 owners each in the 13.3% California income tax bracket: without PTET, owners each pay $133K in CA tax, deductible only up to $10K on federal return — losing ~$123K per owner of federal deduction. With PTET, the entity pays $266K in CA PTET, deducted fully as a business expense at the entity level (saving ~$93K in federal income tax at 35% marginal rate). Net federal tax savings from PTET: ~$93K — a significant benefit for profitable pass-throughs in high-tax states.
The Tax Cuts and Jobs Act of 2017 (TCJA) limited the federal itemized deduction for state and local taxes (SALT) to $10,000/year for individual taxpayers. For a high-income business owner in California or New York paying $80,000+ in state income taxes annually, this cap eliminated most of the federal deduction value. PTET moves the state tax payment to the entity level, where it's deducted as a business expense with no SALT cap. IRS Notice 2020-75 (irs.gov/pub/irs-drop/n-20-75.pdf) confirmed this structure is permissible — making PTET one of the highest-value tax planning opportunities available to pass-through business owners in high-tax states.
Eligible entities vary by state, but most state PTETs cover partnerships (including multi-member LLCs taxed as partnerships) and S corporations. C corporations are generally excluded — they already deduct state income taxes as business expenses without restriction. Single-member LLCs taxed as sole proprietorships are also typically excluded. Check your specific state's PTET statute or IRS Notice 2020-75 (irs.gov) for the current entity eligibility rules in your jurisdiction.
No — when properly structured, PTET is tax-neutral at the state level (the state credit offsets personal state tax dollar-for-dollar) while producing a net federal tax benefit (the entity deduction reduces federal taxable income). The net economic effect is a reduction in combined federal+state tax. The benefit depends on your federal marginal rate — the higher your federal rate, the more valuable the PTET deduction. At a 37% federal marginal rate, each $1 in PTET deduction reduces federal tax by $0.37. Confirm state-level implementation with your tax advisor; see irs.gov for IRS guidance.