PTET: How the Pass-Through Entity Tax Beats the SALT Cap

PTET stands for pass-through entity tax. It is an income tax that a state imposes on a partnership or S corporation at the entity level, on the entity’s own income, in place of collecting that same tax from the owners individually. The owners then get a credit against their state income tax for what the entity paid. Economically nothing moves, the state collects the same money from the same business. Federally, everything moves, because the deduction relocates from a capped individual itemized deduction to an uncapped business expense.

The mechanism turns on IRC section 164. Subsection (a) lets a taxpayer deduct state and local income taxes. Subsection (b)(6), added in 2017, caps that deduction for individuals. The 2025 federal tax act raised the cap and set it on a schedule that steps up through 2029 before reverting, with a phase-down that reduces the benefit above a modified adjusted gross income threshold. None of that touches businesses. A partnership computing its ordinary business income deducts the taxes it pays as an expense, full stop, and passes a smaller number through on the Schedule K-1.

Work the arithmetic on a real set of facts. A New York City architecture partnership has $1,200,000 of ordinary income allocable to a single resident partner who files jointly and is in the 37% federal bracket. Without a PTET election, that $1,200,000 flows to the partner on a Schedule K-1, the partner pays New York State and City personal income tax of roughly $126,000 on it, and the federal deduction for that $126,000 is limited by the section 164(b)(6) cap, which is already fully consumed by the partner’s property taxes on a Brooklyn brownstone. The federal benefit of the $126,000 state tax payment is approximately zero.

With the election, the partnership computes and pays New York PTET on $1,200,000. New York’s schedule is 6.85% on pass-through entity taxable income up to $2,000,000, so the PTET is $82,200. The partnership deducts that $82,200 on its Form 1065, and the partner’s K-1 ordinary income drops from $1,200,000 to $1,117,800. At a 37% marginal rate, the partner’s federal tax falls by about $30,414. The partner then claims an $82,200 credit on Form IT-653 against a New York liability that has not changed, and adds $82,200 back to New York income on Form IT-225 so the state is not funding its own workaround. Net result: the same state tax bill, roughly $30,000 less federal tax, on a single partner.

Now the correction almost nobody makes on the first pass. If the partner qualifies for the section 199A qualified business income deduction, the $82,200 that just came out of ordinary income also came out of qualified business income. The 199A deduction shrinks by 20% of $82,200, or $16,440, and the federal tax on that lost deduction is about $6,082 at 37%. The true net saving is closer to $24,300 than $30,400. It is still a large number for a piece of paperwork, but a plan modeled without the 199A drag overstates the benefit by roughly 20% every time. Architecture, health, law, accounting, consulting, and financial services owners above the income thresholds are already phased out of 199A entirely, so the drag does not apply to them, which is one of the few situations where being a specified service trade or business helps.

The federal authority for all of this is Notice 2020-75, issued November 9, 2020. It announced that forthcoming proposed regulations would confirm that a specified income tax payment made by a partnership or S corporation to a domestic jurisdiction is deductible by the entity in computing its non-separately stated income, and is not subject to the individual SALT cap when it flows through. The notice covers mandatory and elective regimes alike and applies to payments made on or after the notice date. The proposed regulations it promised have still not been issued, which is worth knowing but has not stopped anyone: states kept enacting programs and the IRS has not walked the position back. The 2025 legislation that raised the SALT cap considered restricting PTET for service businesses and dropped the provision.

Not every entity can play. Sole proprietorships filing Schedule C have no entity to impose the tax on. Single-member LLCs that have not elected corporate treatment are disregarded, and New York expressly excludes them unless they are treated as S corporations for state purposes. Publicly traded partnerships, trusts, and nonprofits are typically out. And a partner that is itself a partnership generally cannot claim the credit or push it down to its own partners, which is a structural problem for tiered partnerships and fund structures that no state has solved elegantly. Trusts and estates that hold a direct interest usually can claim the credit on the fiduciary return, but in New York a trust cannot pass the credit through to its beneficiaries, so a family that runs business income through a non-grantor trust needs to check where the credit actually lands before assuming it helps anyone.

The common mistake: assuming the election is a pure win and making it without running the owner-level numbers. In a state with a modest PTET rate and a generous standard deduction, a partner who does not itemize, has heavy 199A benefits, and lives in a different state can end up with a federal saving of a few hundred dollars and a state credit mismatch that costs more than that to resolve. The second mistake is electing in one state and forgetting the resident state’s credit rule, which we cover below. The third is treating PTET as an accounting-department task rather than an owner-level decision. The deduction shows up on everybody’s K-1 whether the individual benefits or not.

The forward-looking piece is the 2030 reversion. The elevated SALT cap is scheduled to drop back to $10,000, which makes PTET dramatically more valuable again for owners who found it marginal in the interim years. States are unlikely to repeal programs that cost them nothing. Build the election into the annual calendar rather than re-deciding it under pressure each March, and revisit the analysis whenever the federal cap changes. Our tax strategy guides track the moving pieces. This page is general information, not tax or legal advice; a licensed CPA should model your entity and your owners before you elect.

This is the question that costs clients the most money, because the answer is different in every state and because the deadline in the largest states falls inside the tax year rather than at filing time. There is no federal election, no federal due date, and no federal extension. A missed state PTET election is generally gone.

New York is the strictest of the big states and a good baseline. Under Article 24-A, an eligible partnership or New York S corporation may opt in on or after January 1 and no later than March 15 of the taxable year. That means the 2027 election closes on March 15, 2027, eleven months before the 2027 partnership return is due, and about two weeks before most firms have even finished the prior year’s returns. The election is annual, so it must be made again every year. It is irrevocable after the due date of the entity’s first estimated payment, though it can be revoked online up until that point. And only an authorized person may make it: a partner, member, or officer with authority to bind the entity, signing under penalty of perjury through the entity’s own Business Online Services account. The Department expressly prohibits tax professionals from making the election on a client’s behalf, which surprises people every single year.

Other states do it differently, and the variety is the point. Several put the election on the entity’s return itself, so it is made at filing time with extensions available. California requires an elective-tax prepayment by June 15 of the tax year, the greater of $1,000 or 50% of the prior year’s elective tax, and missing that prepayment forfeits the election for the year even if the entity is willing to pay in full later. Some states make the election binding for multiple years. A few require consent from owners representing a majority of interests, documented in the entity’s records. Connecticut ran a mandatory regime for several years before converting it to an elective one for tax years beginning on or after January 1, 2024. There is no shortcut here: you look up each state where the entity has an election opportunity, every year.

Estimated payments are the second deadline, and in most states they are mandatory rather than optional. New York requires four payments, due March 15, June 15, September 15, and December 15 of the tax year, each at least 25% of the required annual payment. The required annual payment is the lesser of 90% of the current year’s PTET or 100% of the prior year’s PTET, and if the entity did not elect last year, it is 90% of the current year. Payments must be made by ACH debit through the entity’s online account, the state will not take a check, and the annualized installment method that individuals use to reduce underpayment penalties is not available.

Here is the arithmetic of a miss. A three-partner consulting S corporation in Manhattan expects $2,400,000 of New York-sourced income for 2027. Elected properly, the PTET would be roughly $2,000,000 at 6.85% plus $400,000 at 9.65%, or about $175,600. Deducted federally against three partners in the 37% bracket, that is about $64,972 of federal tax saved, less roughly $12,900 of 199A drag if the partners qualified, call it $52,000 net, or about $17,300 each. The controller was out on leave in March, nobody filed the election, and the entire benefit is gone. There is no late election, no reasonable-cause relief, and no amended-return fix. The next opportunity is March 15 of the following year, for the following year’s income. There is one narrow consolation: because the election is annual, a miss costs one year rather than the arrangement permanently, and the federal deduction described in Notice 2020-75 is available again the following year. That is cold comfort in a year when the business sold a division or had an unusually large allocation, which is precisely when owners notice the election exists.

A related trap: electing and then not funding. The federal deduction for a cash-method entity belongs to the year of payment. An entity that elects for 2027 but does not pay until it files in March 2028 has a valid 2027 state credit for the owners and a 2028 federal deduction for the entity, a full-year mismatch. In a year with an unusually large allocation or a business sale, that slippage can eliminate most of the benefit. Accrual-method entities get somewhat more room under the economic performance and recurring-item rules in IRC section 461, but the clean answer for everyone is to fund the full expected liability before December 31.

Overpayments are their own hazard. New York does not allow an electing entity to move PTET money anywhere else, not to its other tax accounts, not to a related entity, and not to the partners’ personal estimated tax accounts. An entity that overpays gets a refund check after the return is filed, which can take months. An entity that elected, paid $220,000, and then had a loss year has effectively made an interest-free loan to the state until the refund clears.

The common mistake: treating the election as part of tax return preparation. It is not. It is a first-quarter operational task that belongs on the entity’s compliance calendar next to payroll deposits, with a named owner and a reminder set for early February. The second common mistake is letting the CPA firm try to file it in states that require an authorized person, then discovering in April that the submission was rejected. The third is electing in the entity’s home state and forgetting the four other states where it has apportioned income and a separate election opportunity.

Going forward, build a two-page PTET calendar for every entity: each state, the election due date, the election method, who is authorized to make it, the estimated payment dates, and the year-end funding target. Review it in January with the owners, not in March with the preparer. For a look at how the deadlines and prepayment rules work in California specifically, see our California PTET guide. This is general information rather than advice for your entity; confirm every date with the applicable state and a licensed CPA before relying on it.

The entity pays the tax and the owner claims a credit for it. That sentence hides four separate reporting steps, and getting any one of them wrong produces a notice, a reduced refund, or a credit the state simply refuses to allow.

Step one: the entity reports each owner’s share. A New York partnership reports the partner’s classification as resident or nonresident and the partner’s direct share of the PTET on Form IT-204-IP, the New York Partner’s Schedule K-1. An S corporation provides an equivalent statement to each shareholder. New York’s return application collects an eligible-claimant list, name, identification number, ownership percentage, share of the credit, residency status, taxpayer type, for every owner. Once the entity submits its annual PTET return, that information cannot be changed. If a name or a taxpayer identification number is wrong, that owner may be denied the credit outright, and the entity cannot amend it without a specific request to the Department. This is not a formality, and it is the single most common source of denied PTET credits.

Step two: the owner claims the credit. A New York individual attaches Form IT-653 to the personal income tax return. If the individual owns interests in several electing entities, the credits aggregate. The credit is refundable in effect: if it exceeds the tax due for the year, the excess is treated as an overpayment and is credited or refunded without interest. Note two exclusions. The credit cannot be claimed on a group return for nonresident partners or shareholders, so an owner who has been riding a composite return has to file individually to get it. And only direct owners qualify. A partner that is itself a partnership cannot claim the credit and cannot push it down to its own partners, which quietly breaks tiered structures.

Step three: the owner adds the income back at the state level. This is the part that confuses people, and the logic is straightforward once you see it. The federal deduction at the entity level reduced the owner’s federal adjusted gross income. New York starts its personal income tax computation from federal AGI, which is exactly where the Notice 2020-75 deduction landed after escaping the section 164(b)(6) cap. If the state did nothing, it would be funding the federal workaround out of its own revenue. So it requires an addition modification on Form IT-225 equal to the PTET credit being claimed, restoring the state base to where it would have been. Nearly every PTET state has an equivalent provision. The owner is not paying twice; the owner is paying the same state tax through a different channel.

Step four: the owner handles other states. Covered in the next question, and the place where multistate owners lose money.

Two categories of owner need their own treatment. A trust or estate holding a direct interest is an eligible claimant in most states and takes the credit on its fiduciary return, but New York does not let the trust distribute the credit to beneficiaries, so income pushed out on a Schedule K-1 carries the tax without the offset. And a disregarded single-member LLC that holds the partnership interest is looked through: the federal Schedule K-1 issued to the LLC is treated as issued to the individual behind it, and the credit belongs to that individual, who must be named on the entity’s claimant list under their own identification number.

Here is a complete owner-level walk-through. A New York resident owns 40% of an electing partnership with $3,000,000 of pass-through entity taxable income. The entity’s PTET is $2,000,000 at 6.85% plus $1,000,000 at 9.65%, or $137,000 plus $96,500, totaling $233,500. Our partner’s direct share is 40%, so $93,400. Federally, the partnership’s ordinary income was reduced by the full $233,500, so this partner’s K-1 shows $93,400 less income than it otherwise would. At a 37% marginal rate that is $34,558 of federal tax saved, reduced by the 199A effect if the partner qualifies. On the New York return, the partner reports the K-1 income as reduced federally, then adds back $93,400 on Form IT-225, then claims a $93,400 credit on Form IT-653. New York tax is computed on the restored base and reduced dollar for dollar by the credit. New York collects exactly what it would have collected without the election, and the federal government collects about $34,000 less.

Basis and capital accounts follow the deduction, not the credit. The PTET payment is an entity-level expense that reduces the partner’s outside basis under the ordinary rules and reduces the capital account. The credit is a personal-level item and does nothing to basis. Partnerships whose agreements predate 2021 often say nothing about how to allocate a payment that benefits only the individual partners, so a corporate partner or a partnership partner absorbs a share of an expense that buys them no credit. Fixing that requires a special allocation or a capital account adjustment under IRC section 704, drafted before the first election rather than after the first complaint.

The common mistake: claiming the credit and skipping the addback. It produces a lower state tax bill for one filing season and a Department notice with interest afterward. The mirror-image error is adding back the income and forgetting to attach the credit form, which overstates state tax by the full credit amount and requires an amended return. A third recurring problem is the entity reporting an owner’s information incorrectly on the annual PTET return, a maiden name, a transposed digit in a TIN, a partner who was admitted mid-year, and the individual’s credit being denied for a mismatch the individual cannot fix alone.

Practically, reconcile at both ends every year. Before the entity submits the annual PTET return, circulate the eligible-claimant list to the owners and have each one confirm their own name, identification number, and ownership percentage in writing. After filing, give every owner a one-page statement showing their PTET share, the credit form to attach, and the addback amount, so their personal preparer has no reason to guess. Our individual return and corporate return work is coordinated for exactly this reason. This is general information and not advice for your return; have a licensed CPA review the entity filing and the owner filings together.

For most owners of profitable pass-through businesses in income-tax states, yes, and for the highest earners it may be worth more than it was before, because of how the new cap phases down. But the answer is genuinely closer than it was from 2018 through 2024, and a few owners should now skip the election.

Start with the change. IRC section 164(b)(6) capped the individual SALT deduction at $10,000 beginning in 2018. The 2025 federal tax act raised that cap substantially for 2025 and put it on a schedule that increases modestly each year through 2029 before dropping back to $10,000 in 2030. It also added a phase-down: above a modified adjusted gross income threshold, the cap is reduced, though not below the original $10,000 floor. Confirm the current-year cap, threshold, and phase-down percentage from the IRS instructions before you model anything, because these figures step every year by statute.

Two more inputs belong in the model before the cases. The first is the compliance cost, which is real: an entity return in each electing state, four estimated payments, an owner-level credit form and addback in each state, and the coordination time to get the claimant list right. Budget one to several thousand dollars a year depending on how many states and owners are involved. The second is cash flow, since the entity now funds quarterly payments that used to come out of the owners’ personal accounts, and distributions have to be adjusted so nobody is short in April.

The federal deduction itself rests on Notice 2020-75, and the offset comes from IRC section 199A. Both belong in the model.

Now the four cases.

Case one: high-income owner, high-tax state. A New York City partner with $1,800,000 of pass-through income pays well over $200,000 of combined state and city tax. Even a materially higher SALT cap absorbs a small fraction of that. The phase-down makes it worse. The owner’s income is far above the threshold, so the cap is reduced toward the floor. PTET moves the entire state tax bill outside the cap. This owner should almost certainly elect, and the case is stronger, not weaker, than it was under the old rules.

Case two: moderate-income owner, high-tax state. An owner with $320,000 of pass-through income in New Jersey pays perhaps $18,000 of state income tax and $14,000 of property tax. Under a $40,000-range cap, most of that $32,000 is now deductible without any election. The PTET benefit shrinks to the deduction for the amount above the cap, less the 199A drag. It may still be positive; it is no longer obviously worth the compliance cost, the irrevocable election, and the estimated payment schedule.

Case three: owner just above the phase-down threshold. This is the interesting one, and it argues for electing. Because PTET reduces the entity’s ordinary income, it reduces the owner’s federal adjusted gross income, which is the input to the phase-down calculation. An owner whose modified AGI sits modestly above the threshold can use the PTET deduction to pull income down and partially restore the higher cap, capturing two benefits from one payment. That interaction is worth modeling precisely rather than estimating.

Case four: owner in a no-income-tax state. Nothing to elect. Texas, Florida, Nevada, Washington, South Dakota, Wyoming, Alaska, and Tennessee have no individual income tax on this kind of income and no PTET to speak of. An owner in one of those states with income sourced to a PTET state may still benefit through the entity, but the resident-state credit question does not arise.

Run case one with numbers. Combined New York State and City tax on $1,800,000 of pass-through income is roughly $195,000, and the owner also pays $32,000 of real property tax. With a cap in the $40,000 range that is reduced by the phase-down toward $10,000, call the allowed itemized SALT deduction $10,000 against $227,000 of actual state and local taxes. Without PTET, $217,000 of real tax payments produce no federal deduction at all. With PTET, the entity pays approximately $167,000 of New York PTET on the state portion, deducts it, and the owner’s K-1 income drops accordingly. At 37%, that is roughly $61,800 of federal tax saved. The owner is a specified service business owner well past the 199A thresholds, so there is no 199A drag to subtract. The compliance cost is an election, four estimated payments, an entity return, and two extra forms on the personal return. That is a very good trade.

Run case two and it flips closer. State income tax of $18,000, property tax of $14,000, allowed cap of $40,000 with no phase-down: all $32,000 is already deductible. Electing PTET moves $18,000 of it to the entity level, where it is deductible anyway. The federal benefit of the shift is close to zero, and the 199A reduction of $3,600 at a 32% rate costs about $1,150. This owner is worse off electing. The election is not free, and pretending otherwise is how advisors lose credibility.

The common mistake: deciding once and never revisiting. The cap steps annually through 2029 and reverts in 2030. An owner who correctly skipped the election in a middling year may be badly wrong two years later, and an owner who elected in 2021 may be paying compliance costs for a benefit that shrank. Because most state elections are annual and irrevocable, the decision has to be re-run each January with current-year figures. The second common mistake is modeling the federal saving without the 199A offset, which overstates the benefit by roughly 20% for any owner who still qualifies for the deduction.

The practical rule we use: model the owner’s return both ways with actual current-year numbers before the state’s election deadline, not after. If the spread is under a few thousand dollars, weigh the administrative burden, the irrevocability, and the cash-flow effect of quarterly entity payments before electing. And plan now for 2030, when the cap is scheduled to fall back and the calculation returns to being one-sided. See our state tax questions guide for the residency and sourcing rules that feed this analysis. Nothing here is tax advice for your situation; a licensed CPA should run your numbers before an election you cannot take back.

More than thirty states plus New York City have enacted an entity-level tax since Notice 2020-75, and almost none of them did it the same way. The differences are not cosmetic. They change who can elect, when, what gets taxed, and whether the owner’s home state will honor the payment. For a business operating in three states with owners living in two others, this is the hardest planning problem in the whole area.

The one thing they share is the federal treatment. Notice 2020-75 covers any specified income tax payment a partnership or S corporation makes to a domestic jurisdiction, mandatory or elective, so the entity-level deduction works the same way in every state that has imposed one and the section 164(b)(6) cap stays out of it. Everything below the federal line is state-specific.

Six variables move from state to state. Election timing ranges from an in-year deadline (New York’s March 15 of the tax year) to an election made on the filed return, with California requiring a June 15 prepayment to preserve it. Election duration is annual in most states and binding for multiple years in a few. Who may elect varies: some states require owner consent representing a majority of interests; New York requires an authorized person and bars the preparer. The tax base differs, some states tax only the income allocable to individual owners, others tax all income and let corporate owners sort it out; some tax only in-state sourced income, others give resident owners a broader base. Rates range from flat percentages near the state’s top individual rate to graduated schedules like New York’s 6.85% to 10.90% ladder. The owner benefit is a credit in most states, an income exclusion or subtraction in others, and that distinction matters enormously for the next question.

The resident credit is where multistate owners lose money. Every state that taxes residents on worldwide income gives a credit for income taxes paid to other states, so the same income is not taxed twice. But those credit statutes were written for taxes imposed on the individual. A PTET is imposed on the entity. Some states amended their credit statutes to cover entity-level taxes paid on the resident’s behalf. Some limit the credit to taxes “substantially similar” to their own PTET, which excludes states whose programs are structured as an exclusion rather than a credit. And some have not addressed it at all, leaving a resident owner with a nonresident-state entity payment that produces a federal deduction and no home-state credit, which can be a net loss.

New York publishes an explicit list of jurisdictions whose taxes it treats as substantially similar for resident credit purposes, and requires the resident to make an addition modification on Form IT-225 equal to the other state’s entity-level tax that supports the credit. That is exactly the kind of rule that has to be checked in the resident state, in the source state, and for the specific year, because the lists get updated.

Work an example that goes wrong. A design firm is organized as an LLC taxed as a partnership, does business in New York, New Jersey, and Connecticut, and has three equal partners: one living in New York, one in Connecticut, and one in Florida. The firm elects PTET in all three operating states and pays a combined $310,000 of entity-level tax. The New York resident partner gets a New York credit for the New York PTET and a resident credit for the New Jersey and Connecticut portions, assuming both are on New York’s substantially-similar list, check it, do not assume. The Connecticut resident partner needs Connecticut to allow a credit for New York and New Jersey entity-level tax. The Florida partner has no state return at all, so the credits are worthless to her, but her K-1 income was reduced by one third of the full $310,000, or about $103,333, which produces roughly $38,000 of federal tax saving at 37%. She is the biggest winner in the room and paid nothing for it, while the other two partners absorbed the same reduction and got credits that merely offset tax they owed anyway. Unless the operating agreement allocates the burden and benefit deliberately, this is a real economic transfer among partners, and it is invisible on the K-1s.

Nonresident composite and withholding regimes interact badly too. Many states require a partnership to withhold on nonresident owners or file a composite return for them. Electing PTET does not automatically switch those obligations off, and in some states an owner included in a composite return is disqualified from claiming the PTET credit individually. New York specifically bars claiming the credit on a group return for nonresident partners or shareholders. So an out-of-state owner who has always been swept into a composite filing has to be pulled out and filed individually to capture the credit, which is more work and a different fee.

The common mistake: electing everywhere the entity does business, on the theory that more deduction is better. It is not, if a partner’s resident state refuses the credit for that state’s entity-level tax. The deduction is worth 37 cents on the dollar; the lost credit is worth 100 cents on the dollar. The second mistake is ignoring what the election does to nonresident and corporate owners who receive no benefit and absorb the expense. The third is assuming a state has a PTET at all. A handful of income-tax states still have not enacted one, and Pennsylvania has long been the notable holdout among large states, so verify rather than assume.

The workable method is a matrix. List every state where the entity has filing obligations down one axis and every owner across the other. For each cell, record whether an election is available, what the deadline and method are, whether that owner is an eligible credit claimant, and whether that owner’s resident state allows a credit for the payment. Build it once, update it each January, and let it drive the elections. Then check whether the partnership agreement allocates the PTET burden in a way that matches who actually benefits, because the default allocation almost never does. For a state-by-state look at residency and sourcing questions, see our state tax questions guide, and for California’s own rules our California PTET guide. This page is general information and not tax or legal advice for your entity or its owners; confirm every state’s current rules with a licensed CPA before electing.