PTE Tax
Pass-Through Entity (PTE) Tax is a state-level election allowing a partnership or S-corporation to pay state income tax at the entity level rather than passing through to owners. The entity-level payment is fully deductible federally as a business expense, bypassing the $10,000 SALT cap that applies to individual state-tax deductions. The owners receive a state-level credit for the tax paid by the entity.
The TCJA-era SALT cap (effective 2018) limits state and local tax deductions to $10,000 per individual return. For pass-through-entity owners in high-tax states, this was a meaningful constraint — a New York or California owner with $1M of K-1 income previously deducted ~$80k–$130k of state income tax federally; capped at $10k, they lost most of that deduction.
IRS Notice 2020-75 (issued November 2020) blessed a state-level workaround: if the state authorizes the entity to pay the state tax directly, the entity's payment is a deduction at the entity level (above the line), reducing the K-1 income that flows to the owner. The owner then receives a state-level credit (or exclusion) for the state tax paid on their behalf. The federal deduction at the entity level is not subject to the SALT cap because it's not an individual itemized deduction.
As of 2026, 36+ states have enacted PTE tax regimes. The mechanics vary: some require an annual election (e.g., California), some require multi-year commitments (e.g., New York), some apply only to LLCs (some states exclude S-corps), some distinguish between resident and non-resident owners. The election is generally made at the entity level (not the owner level), so all owners must agree. The federal benefit is uniform across states (avoiding the $10k SALT cap), but the state-level credit treatment varies — most states give a dollar-for-dollar resident credit, but a few impose haircuts for non-resident owners.
Synthetic households with K-1-producing entities in high-tax states (CA, NY, NJ, MA, CT, OR) should include PTE-tax-elected entities. The K-1 should reflect both the entity-level state tax paid and the corresponding state-level credit allowed to the owner. Tax-projection engines need to model the federal deduction at the entity level (reducing K-1 income) and the state credit at the owner level (reducing state tax).
Common pitfalls
- Failing to make the annual PTE election by the state's deadline — most states require an election by the entity's filing deadline, with no late-election relief.
- Treating the entity-level state tax as still deductible by the owner under §164 — IRS Notice 2020-75 blessed the entity-level deduction; the owner cannot also claim a separate §164 deduction for the same tax.
- Forgetting the state-level non-resident haircut — some states (e.g., New Jersey for non-residents) limit the resident credit, leaving non-resident owners worse off than residents.
- Mixing state regimes — multi-state pass-throughs with PTE elections in some states and not others require carefully tracking which states' tax is at the entity level vs. owner level.
Examples
California S-corporation owner with $1M K-1 income, 13.3% state rate: pre-TCJA, deducted $133,000 federally; post-TCJA, deducted only $10,000 (SALT cap). With CA PTE election: entity pays $93,000 of CA tax (9.3% × $1M elected portion), deducting it federally and reducing federal taxable income by $93,000. Owner federal benefit: $93,000 × 37% = $34,410. Owner CA credit: $93,000 against owner's CA tax bill. Net: ~$24,000 federal benefit relative to no PTE election.