What Is PTE Tax?

Pass-Through Entity (PTE) tax, also called an entity-level state income tax or SALT cap workaround, is a mechanism enacted by most U.S. states that allows partnerships, S corporations, and in some states LLCs taxed as pass-throughs, to elect to pay state income tax at the entity level rather than at the individual owner level. The strategy is specifically designed to circumvent the federal $10,000 SALT deduction cap imposed by the Tax Cuts and Jobs Act (TCJA).

Why PTE Tax Was Created

Prior to TCJA (2018), individual taxpayers could deduct all state and local income taxes paid as an itemized deduction on Schedule A. TCJA capped the combined SALT deduction at $10,000 per year ($5,000 MFS) for tax years 2018–2025. This cap particularly harmed owners of pass-through businesses (S-corps, partnerships) in high-tax states, who were paying state income taxes on business income but could no longer fully deduct those taxes on their federal returns.

The IRS confirmed in Notice 2020-75 that states may impose entity-level income taxes on pass-through entities, and that such taxes are deductible by the entity as an ordinary business expense — without being subject to the individual SALT cap.

How the Mechanism Works

When a pass-through entity makes the PTE tax election:

• The entity pays state income tax on its owners' distributive share of income at the entity level
• The entity deducts those state tax payments as an ordinary and necessary business expense on its federal return — reducing federal taxable income passed through to the owners
• The individual owners receive a state-level credit, exclusion, or deduction for their share of the PTE tax paid, preventing double taxation at the state level
• The net effect is that the owner receives an effective federal deduction for state taxes on business income that would otherwise be capped at $10,000

The New "Tiered" SALT Cap (2025–2029)

• The New Limit: The SALT cap has been raised to $40,000 ($20,000 for MFS) for taxpayers with a Modified Adjusted Gross Income (MAGI) below $500,000.
• The Phase-Down: If your MAGI is between $500,000 and $600,000, the cap is reduced by 30 cents for every dollar over the threshold.
• The Floor: Regardless of how high your income is, the SALT cap will not fall below $10,000.

Availability by State

As of 2025, more than 36 states have enacted a PTE tax regime. Major states with active PTE tax elections include California, New York, New Jersey, Illinois, Massachusetts, Virginia, Colorado, Connecticut, and Georgia. Each state's PTE tax regime has unique rules regarding eligibility, election timing, calculation method, and the form of owner-level relief (credit vs. deduction vs. exclusion).

Who Benefits Most

PTE tax elections are most beneficial for:

• S-corporation shareholders and partners in high-tax states whose total SALT liability exceeds $10,000
• Owners in the 32%–37% federal tax brackets where the benefit of the above-the-line federal deduction is highest
• Pass-through entities in states with high marginal income tax rates (California at 13.3%, New York City up to 14.776% combined, New Jersey at 10.75%)

Federal Reporting

At the entity level, the PTE tax payment is deducted on the entity's tax return (Form 1065 for partnerships, Form 1120-S for S-corps) as a state and local tax expense, reducing net income passed through to owners. Each owner's K-1 reflects their reduced share of income. On their individual return, owners may still need to report PTE-related items on Schedule A or their state return depending on jurisdiction.

TCJA Sunset Consideration

The individual SALT cap is currently scheduled to expire after December 31, 2025. If the cap is allowed to expire, the strategic rationale for PTE tax elections diminishes significantly. If it is extended (as proposed in various legislative packages as of 2025), PTE tax elections remain highly relevant. Entities should make their election decision with awareness of the legislative environment.

Related Questions

• Do I need to file tax returns in every state where I work as a travel nurse?

Sources:

IRS Notice 2020-75 — Deductibility of entity-level state income taxes

IRC §164(b)(6)

IRC §164(a)(3)

IRS Form 1065 — U.S. Return of Partnership Income

IRS Form 1120-S — U.S. Income Tax Return for an S Corporation