Pass-Through Entity Tax (PTET) by State Explained

A pass-through entity tax (PTET) is an elective state income tax paid by a partnership or S corporation on behalf of its owners, designed to get around the federal cap on deducting state and local taxes. The business deducts the state tax on its federal return, owners receive a state credit, and the result is usually a lower combined federal tax bill. Roughly three dozen states offer some version, and the 2025 federal tax law kept the workaround intact.

This guide explains how the pass-through entity tax works, how the new $40,000 SALT cap changes the math, how a few major states handle the election, a worked example, and the mistakes owners make. It is general information, not tax advice. PTET rules differ by state and change often, so confirm details with your state tax agency or a CPA before electing.

Why the pass-through entity tax exists

From 2018, individuals could deduct no more than $10,000 of state and local taxes (SALT) on Schedule A. Owners of partnerships and S corporations in high-tax states were hit hard because their business profits flow onto their personal returns and are taxed by the state at the individual level.

States responded by letting the business pay the tax instead. In Notice 2020-75, the IRS confirmed that state income taxes imposed on and paid by a partnership or S corporation are deductible by the entity and are not subject to the individual SALT cap. Most states with an income tax have since enacted a PTET.

The SALT cap after the 2025 tax law

Tax year	Individual SALT cap	Notes
2018-2024	$10,000	$5,000 married filing separately
2025	$40,000	Reduced for MAGI over $500,000, but not below $10,000
2026	$40,400	Cap and income threshold rise 1% a year
2027-2029	Rises 1% a year	Phase-down continues for high incomes
2030 onward	$10,000	Scheduled reversion

Above the income threshold, the cap is reduced by 30% of the excess, down to a $10,000 floor. In practice, an owner with MAGI around $600,000 or more is back at roughly $10,000, exactly the group most likely to benefit from PTET. Commentary such as The Tax Adviser's analysis of the 2025 SALT changes notes that the PTET workaround survived the legislation.

How a PTET election works, step by step

1. The entity elects. A partnership or S corporation makes the annual election, often requiring owner consent.
2. The entity pays state tax on its qualified net income, usually through estimated payments during the year.
3. The entity deducts the payment on Form 1065 or Form 1120-S, which lowers the ordinary income on each owner's K-1.
4. Owners claim a state credit (or exclusion) on their personal state returns for their share of the tax paid.
5. Owners pay less federal tax because their federal taxable income is lower, while their state tax is roughly unchanged.

PTET by state: examples

Each state's program is different. A few widely used ones:

State	Key features	Election timing
California	Elective tax of 9.3% on qualified net income; extended for tax years 2026 through 2030	Made on a timely filed return; first payment due by June 15 of the election year
New York State	Graduated rates on the entity's taxable income; separate New York City PTET for eligible entities	By March 15 of the tax year
New Jersey	Long-running elective program with graduated rates	Annual election; confirm the current date with the NJ Division of Taxation
Colorado, Iowa, Massachusetts, Michigan, Minnesota	Programs linked to the federal SALT cap	Varies by state

California's Franchise Tax Board describes its program on its pass-through entity elective tax page, including the June 15 payment and the 2026-2030 extension. For other states, look for "pass-through entity tax" or "elective entity tax" on the state revenue department's site, and confirm whether the program is permanent or tied to the federal cap.

Worked example: two-owner S corp

Illustrative numbers. A two-owner S corporation in a state with a 9% flat PTET rate earns $500,000 of qualified net income in 2026. Each owner has a 50% share ($250,000), pays $14,000 of property tax and has total MAGI of about $650,000 from all sources, so each owner's SALT cap is phased back to $10,000.

	Without PTET (per owner)	With PTET (per owner)
K-1 ordinary income	$250,000	$227,500 (after $22,500 PTET deduction)
State income tax on business share	$22,500 paid personally	$22,500 paid by entity; credit on state return
SALT deducted on Schedule A	$10,000 (capped; property tax alone uses it)	$10,000 (property tax)
Extra federal deduction	$0	$22,500
Federal tax saving at 35%	n/a	About $7,875

The state tax is the same either way, but moving it to the entity converts $22,500 of non-deductible tax into a deduction. Reduce the saving slightly for the lower QBI deduction and any added preparation fees. Across both owners, that is roughly $15,000 a year.

Contrast an owner with $120,000 of income, $5,000 of state income tax and $4,000 of property tax: total SALT of $9,000 fits under the cap, so PTET adds almost nothing.

Questions to answer before you elect

Before signing the election, work through these with your preparer:

1. Are all owners on board? Some states require every owner to consent, and others let individual owners opt in or out. An owner who gains nothing (for example, a low-income partner under the SALT cap) may still be affected by the entity's cash outlay.
2. Where do the owners live? Resident owners usually get a credit in the same state. Nonresident owners need their home state to give credit for tax paid by the entity to another state, and not every state does.
3. Can the business fund the payments? Estimated PTET payments are due during the year, often before the owners would have paid their own personal estimates.
4. How does the operating agreement treat the payment? If owners have different shares or opt-in choices, the agreement should say how the tax is charged against each owner's distributions.
5. Is the state's program permanent? Several programs were tied to the federal SALT cap and could change if Congress changes the cap again.

How PTET shows up on returns and K-1s

On the federal side, the PTET payment appears as a deduction in computing the entity's ordinary business income, typically within taxes and licenses on Form 1065 or Form 1120-S. It does not appear as a separately stated item on the K-1, which is why it reduces each owner's share of ordinary income. On the state side, the entity reports the tax paid and gives each owner a statement of their share of the credit, which the owner then claims on their personal state return. Owners who also pay personal estimated state tax should reduce those estimates to avoid paying twice and waiting for a refund. Federal estimates change too: a lower K-1 means less federal tax, so revisit how much to set aside for taxes once the election is in place. If you skip that step, you simply overpay and wait for the refund, which ties up cash the business could use for the next state installment or for paying suppliers on time.

Who benefits most from PTET

• Owners of partnerships, multi-member LLCs and S corporations in states with meaningful income tax rates.
• Owners whose MAGI exceeds the SALT phase-down threshold.
• Owners who already use their SALT cap on property taxes.
• Owners who take the standard deduction anyway, since the entity-level deduction works even if they do not itemize.

It usually does not help sole proprietors or single-member LLCs taxed as disregarded entities, since they cannot elect. If you are weighing an S election partly for PTET, read our S corp vs LLC comparison first, and remember that an S corp also needs payroll for working owners.

Common PTET mistakes

• Missing an early election deadline, such as New York's March 15 date.
• Underpaying estimates. Several states require minimum prepayments; California's June 15 payment is the classic trap.
• Nonresident owners. A credit in one state may not be honored by an owner's home state, which can create double tax.
• Ignoring QBI and basis effects. The PTET deduction lowers QBI and affects owner basis calculations; our QBI deduction guide explains the 20% deduction it reduces.
• Claiming the payment twice. Owners must not also deduct the entity's PTET as personal SALT on Schedule A.
• Cash flow surprises. The entity needs cash for estimated payments; collect receivables promptly so the money is there when the state payment is due.

What to do next

Ask your tax preparer to model PTET as part of year-end tax planning, using your projected income and the current SALT cap. Confirm the state's election date and payment schedule, and add them to your 2027 tax deadline calendar. If you are a partnership, our Form 1065 guide explains how the deduction and credits flow to each K-1, and our sibling guide to Schedule K-1 shows where owners see them.

PTET payments come out of the business's cash, so steady invoicing and collections matter more than ever when a large state estimate is due in spring. Send clear invoices with firm due dates and track what is outstanding. Our free invoice generator makes that easy: no sign-up, professional layouts and an instant PDF download for every invoice.