Understanding the Pass-Through Entity Tax (PTET) Election: A Practical Guide for High-Income Business Owners
The Pass-Through Entity Tax (PTET) election has become a valuable strategy for many high-income taxpayers seeking relief from federal limits on state and local tax (SALT) deductions. Although not new, the PTET remains particularly useful for business owners operating through S-corporations or Partnerships entities and are personally affected by the federal SALT cap.
What Is SALT?
SALT stands for State and Local Taxes. These include income taxes, property taxes, and certain other local assessments. Historically, taxpayers who itemized deductions were able to deduct their full SALT payments on their federal returns.
However, major tax legislation placed a cap on that deduction. Before recent changes, the SALT deduction was limited to $10,000 per return if single or married filing jointly, significantly affecting high-income earners in high-tax states.
Newer legislation temporarily increased the allowable SALT deduction to as much as $40,000 for taxpayers with a Modified Adjusted Gross Income (MAGI) below $500,000. But once income reaches about $600,000, the deduction drops back down to the familiar $10,000 cap.
This is where the PTET election becomes highly beneficial.
How the PTET Election Helps
Pass-through entities—such as S-Corporations and Partnerships—can elect to pay state income taxes at the entity level instead of the individual level. This shifts the tax from a nondeductible personal SALT payment to a fully deductible business expense for federal purposes.
This means the business can deduct the state taxes paid on behalf of the shareholders or partners, reducing the federal taxable income of the owners.
A Simplified Example
Suppose a taxpayer earns $600,000 and pays $50,000 in state and local taxes.
Without the PTET election, the individual can typically deduct only $10,000 on their federal return due to the SALT cap.
With the PTET election:
- The S-Corporation or partnership pays the $50,000 to the state (subject to state rules).
- The entity deducts this tax as a business expense.
- The deduction lowers the taxpayer’s federal taxable income.
- The taxpayer receives a state tax credit for the taxes paid on their behalf.
This structure often results in a meaningful reduction in federal tax liability. However, with everything there are pros and cons. With this strategy the potential biggest con is the reduction in qualified business income deduction.
Who Should Consider the PTET Election?
While the strategy is no longer as impactful for moderate-income taxpayers (due to the increased SALT threshold for certain income levels), it remains extremely useful for:
- Individuals earning $600,000+ per year
- Owners of S-Corporations or Partnerships
- Taxpayers residing in states that allow PTET elections
- Those who expect significant state tax liabilities and itemize deductions
Important Considerations
Not all states have adopted PTET legislation, and among those that have, each state sets its own rules regarding:
- Election deadlines
- Payment due dates
- Credit structures
- Eligibility requirements
Because state rules vary significantly, taxpayers should consult a tax professional to ensure compliance and maximize benefits.
Final Thoughts
For high-income owners of pass-through entities, the PTET election remains a powerful planning tool to bypass the SALT deduction limit and reduce federal taxes. Understanding whether your state allows this election—and whether it fits your tax profile—is essential.
If you believe the PTET could benefit your tax situation, consider reviewing your entity structure and state requirements with Thompson Tax Group before year-end deadlines.
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