Maybe the least popular change brought about by the Tax Cuts and Jobs Act (TCJA) was a first-ever cap on the federal personal income tax deduction for state and local taxes. From 2018 through 2025, the TCJA caps itemized deductions for state income taxes (or general sales taxes if elected instead of income taxes), state real property taxes, and personal property taxes at $10,000 (known as the SALT cap).
Thus, for example, if you live in a high-tax state such as California or New York and owe $10,000 or more in property tax, that tax alone uses your $10,000 deduction. You’ll get no federal deduction for the substantial state income taxes you doubtlessly pay.
But suppose you’re an owner of a pass-through entity such as a partnership, multi-member LLC, or S corporation. In that case, there could be a way for you to get around the $10,000 SALT cap by electing to have your pass-through business pay federal income tax on its profits at the entity level.
A majority of states have enacted pass-through entity taxes (PTE taxes).
In these states, pass-through owners can elect to have their entity pay the state income tax due on the entity’s business income that its owners would otherwise pay. The entity then claims a federal business expense deduction for the state income tax payments. The $10,000 SALT cap does not apply to taxes imposed at the business-entity level, such as income taxes imposed on pass-throughs.
Depending on the state where the owners live, they either get a state tax credit for the state tax paid by the entity or exclude from their income for state personal income tax purposes their distributive share of the pass-through’s taxable income.
Either way, the owners benefit from a federal deduction for all the state income tax due on their pass-through income, even if it is far more than the $10,000 SALT limit.
You can do this. The IRS gave its seal of approval to PTE taxes in a Notice issued in November 2020.
Unfortunately, not all business owners can benefit from the PTE. As mentioned above, it’s only for business entities that are subject to pass-through taxation. These include multi-member LLCs, partnerships, single- and multi-owner S corporations. You’re out of luck if you’re a sole proprietor or an owner of a single-member LLC.
To date, 29 states have enacted pass-through entity (PTE) taxes that can enable owners of pass-through entities such as partnerships, multi-member LLCs, and S corporations to effectively get around the federal $10,000 limit on deducting state and local taxes (SALT).
The 29 states are Alabama, Arizona, Arkansas, California, Colorado, Connecticut, Georgia, Idaho, Illinois, Kansas, Louisiana, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, New Jersey, New Mexico, New York, North Carolina, Ohio, Oklahoma, Oregon, Rhode Island, South Carolina, Utah, Virginia, and Wisconsin. PTE tax legislation is pending in Iowa, Pennsylvania, and Vermont.
If your pass-through business is located in one of these states, you may be able to save thousands of dollars in federal income taxes by electing to have your PTE pay the state tax due on its income at the entity level instead of you paying your share of such taxes on your personal return. Reason: When your PTE pays such taxes, it may deduct them in full because it is not subject to the individual $10,000 SALT limit.
Unfortunately, every state’s PTE tax regime is different. Before your PTE makes a PTE tax election, all its owners must understand the issues involved. These include:
- Is your PTE eligible for a PTE tax election?
- What percentage of ownership is required to make the election?
- What’s the deadline for the election?
- Are estimated PTE taxes due?
- How much is the PTE tax?
- Does your state give electing PTE owners a tax credit or income exclusion?
- How are non-resident PTE owners treated?
If you have any questions on the PTE or need my help, don’t hesitate to call us at 951-633-1040. Elite Tax Partners, Inc.
