Pass-Through Entity Tax (PTET): The SALT Cap Workaround for S-Corps and Partnerships

By Yarik Yarosh, CPA ·September 5, 2026 ·8 min read

Written by Yarik Yarosh, CPA (US & Canada) September 5, 2026 · FL CPA license AC61704 · CPA Ontario

The $10,000 SALT deduction cap (raised to $40,000 under the One Big Beautiful Bill Act, $20,000 MFS) limits how much state and local tax individuals can deduct on their federal return. For business owners in high-tax states, this cap created a significant tax increase. The pass-through entity tax (PTET) provides a legitimate workaround: the S-Corp or partnership elects to pay state income tax at the entity level, and that payment is deductible as a business expense under IRC 164, which is not subject to the SALT cap. The IRS confirmed in Notice 2020-75 that entity-level state taxes imposed on pass-through entities are deductible by the entity in computing its non-separately stated income, effectively allowing a full federal deduction for state income taxes that would otherwise be limited. Over 36 states have now enacted PTET legislation, each with its own election deadlines, rates, and mechanics.

✓Key takeaway

How the PTET workaround functions:

Step	Without PTET	With PTET
1. State tax calculated	On owner’s individual return	At the entity level
2. State tax paid by	Individual owner	S-Corp or partnership
3. Federal deduction	Limited by $40K SALT cap (OBBBA)	Fully deductible as business expense (no cap)
4. Owner’s state return	Receives credit or exclusion for PTET paid	Net state tax cost = same
5. Net federal savings	Depends on SALT cap headroom	Full deduction at owner’s marginal rate

PTET vs. no-PTET comparison (high-tax state):

Factor	No PTET	PTET Elected
State income tax on business income	Paid individually	Paid by entity
Federal SALT deduction	Limited to $40K (OBBBA)	No limit (IRC 164 business deduction)
Net federal tax on state taxes	State taxes above SALT cap get no federal benefit	All state taxes generate a federal deduction
Owner’s state return	Normal state tax liability	Credit for PTET paid (net $0 state impact)

Key election requirements (general, varies by state):

Requirement	Typical Rule
Eligible entities	S-Corps, partnerships, LLCs taxed as partnerships
Election timing	Annual; often before the start of the tax year or by March 15
Who elects	Entity (all owners bound, or individual owner opt-in depending on state)
Tax rate	State’s individual income tax rate (or close to it)
Payment timing	Estimated payments required quarterly in most states
Owner credit	Dollar-for-dollar credit on owner’s state return (or income exclusion)

How much does the PTET actually save?

Hypothetical example

Round numbers. An S-Corp owner in a state with a 10% income tax rate. The S-Corp generates $500,000 of pass-through income. The owner is in the 37% federal bracket. The owner also has $15,000 in property taxes.

Without PTET:

Item	Amount
State income tax on S-Corp income (10%)	$50,000
Property taxes	$15,000
Total state and local taxes	$65,000
SALT deduction cap (OBBBA)	$40,000
SALT deduction claimed	$40,000 (capped)
Lost SALT deduction	$25,000
Federal tax lost	$9,250 (37% x $25,000)

With PTET (same scenario):

Item	Amount
PTET paid by S-Corp (10% x $500,000)	$50,000
PTET deduction on federal S-Corp return	$50,000 (full, no SALT cap)
Federal tax savings from PTET deduction	$18,500 (37% x $50,000)
Remaining individual SALT (property taxes)	$15,000
Individual SALT deduction	$15,000 (under $40K cap)
Federal tax savings from property tax deduction	$5,550
Total federal tax savings	$24,050

Comparison:

Metric	Without PTET	With PTET	Savings
Federal deduction for state income tax	$40,000 (capped)	$50,000 (uncapped, at entity level) + $15,000 property tax	$25,000 more deduction
Federal tax savings	$14,800	$24,050	$9,250

The PTET saves $9,250 in federal taxes, which is the value of the $25,000 in state taxes that exceeded the SALT cap.

Higher income scenario (same state, $1,000,000 S-Corp income):

Item	Amount
State income tax on S-Corp income (10%)	$100,000
Property taxes	$15,000
Total state and local taxes	$115,000
SALT deduction cap (OBBBA)	$40,000
SALT deduction claimed (without PTET)	$40,000 (capped)
Lost SALT deduction	$75,000
Federal tax lost	$27,750 (37% x $75,000)

With PTET ($1,000,000 scenario):

Item	Amount
PTET paid by S-Corp (10% x $1,000,000)	$100,000
PTET deduction on federal S-Corp return	$100,000 (full, no SALT cap)
Federal tax savings from PTET deduction	$37,000 (37% x $100,000)
Remaining individual SALT (property taxes)	$15,000
Individual SALT deduction	$15,000 (under $40K cap)
Federal tax savings from property tax deduction	$5,550
Total federal tax savings	$42,550

Metric	Without PTET	With PTET	Savings
Federal tax savings	$14,800	$42,550	$27,750

The PTET saves $27,750 in federal taxes at $1,000,000 income, which is the value of the $75,000 in state taxes that exceeded the SALT cap.

Multi-state considerations:

Factor	Implication
Owner resides in a different state than the entity	PTET applies in the state where the income is sourced, not the owner’s resident state
Multiple states	Entity may need to elect PTET in each state where it has income
Credit mechanics	Owner’s resident state must allow a credit for PTET paid to another state (most do, but not all)
State tax rate differences	PTET rate is the source state’s rate; credit on resident return is at the resident state’s rate

States with PTET as of 2025 (partial list of major states):

State	PTET Available?	Notes
California	Yes	Annual election, 9.3% rate, nonresident owners can opt out
New York	Yes	Annual election by March 15, progressive rates (6.85%-10.9%)
New Jersey	Yes	Mandatory for all pass-through entities with income over $1M
Illinois	Yes	4.95% rate, election by entity
Connecticut	Yes	Mandatory for all pass-through entities
Massachusetts	Yes	5% rate, annual election
Georgia	Yes	5.49% rate (2025)
Florida	No	No state income tax, PTET is irrelevant
Texas	No	No state income tax
Nevada/Wyoming/SD	No	No state income tax

The PTET is less valuable (or irrelevant) when:

Situation	Why
No state income tax	Nothing to deduct
Total SALT under $40K cap (OBBBA)	Already fully deductible without PTET
Owner is in AMT	AMT disallows all SALT; but entity-level PTET may still be deductible (varies)
Owner has significant other itemized deductions	May not itemize even with full SALT deduction
Sole proprietor (Schedule C)	PTET typically not available for sole proprietors (must be an entity)

Illustrative numbers only, not a real client and not advice for your facts.

How does business nexus work for state tax purposes?

Nexus is the minimum connection a business must have with a state before that state can impose its taxes. Physical nexus is established by having employees, property, or inventory in a state. Economic nexus, which has expanded significantly since the Supreme Court’s Wayfair decision (2018), can be triggered by exceeding revenue or transaction thresholds in a state (commonly $100,000 in sales or 200 transactions). Once nexus is established, a business may owe the state’s income tax, franchise tax, sales tax collection obligations, and payroll tax withholding for employees working in that state. Many states offer voluntary disclosure agreements (VDAs) that limit look-back periods and waive penalties for businesses that discover they have unfiled state obligations.

How do specified service trades or businesses affect your QBI deduction?

Specified service trades or businesses (SSTBs) including law, medicine, accounting, consulting, financial services, and performing arts face a phase-out of the QBI deduction at higher income levels. For 2025, the QBI deduction phases out for SSTBs between $191,950 and $241,950 for single filers and $383,900 and $483,900 for joint filers, with zero deduction above the upper threshold. Non-SSTB businesses above the income threshold are limited to the greater of 50% of W-2 wages or 25% of W-2 wages plus 2.5% of the unadjusted basis of qualified property, but they never lose the deduction entirely. The SSTB classification looks at the principal asset of the business, so if more than 10% of gross receipts come from specified service activities (5% for businesses with over $25 million in gross receipts), the entire business is treated as an SSTB.

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Cite this page

Yarik Yarosh, CPA. "Pass-Through Entity Tax (PTET): The SALT Cap Workaround for S-Corps and Partnerships." Blue Cloud CPA, September 5, 2026. https://bluecloudcpa.com/guides/small-business-pass-through-entity-tax-ptet-salt-workaround

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.

Pass-Through Entity Tax (PTET): The SALT Cap Workaround for S-Corps and Partnerships

How much does the PTET actually save?

How does business nexus work for state tax purposes?

How do specified service trades or businesses affect your QBI deduction?

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