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The Tax Cuts and Jobs Act capped the individual deduction for state and local taxes at $10,000 starting in 2018. For owners of partnerships and S corporations in high-tax states, that turned a large deduction into a small one overnight. States responded with a structural fix: let the entity pay the state income tax itself. A business's state taxes are deductible without a cap in computing its income, so the deduction moves from the owner's Schedule A, where it is capped, to the entity's return, where it is not. The owner then gets a state credit or exclusion so the income is not taxed twice at the state level.
01The IRS said yes
Treasury and the IRS confirmed the approach in Notice 2020-75. The notice announced that forthcoming regulations would clarify that "specified income tax payments," meaning state or local income taxes a partnership or S corporation pays on its own income under a law that imposes the tax at the entity level, are deductible by the entity in computing its non-separately stated income, and are not taken into account in applying the owner's SALT cap. The notice applies whether the state's regime is mandatory or elective, and whether the owners receive a credit, an exclusion, or neither.
The 2025 federal tax legislation raised the SALT cap to $40,000 for 2025, with modest annual increases through 2029 and a phase-down for taxpayers with modified adjusted gross income above $500,000, before the cap returns to $10,000 in 2030. It did not close the entity-level route. For owners above the phase-down range, and for everyone once the cap reverts, PTE elections remain as relevant as before. Confirm the current figures against the statute for the year in question; this is an area where the numbers have moved.
02The mechanism in one paragraph
The entity makes the state's election. It computes and pays state tax on the owners' shares of its income at the state's PTE rate, usually through estimated payments during the year. The payment is a deductible expense of the entity for federal purposes, so each owner's K-1 income is lower. On the state return, each owner claims a credit for their share of the entity-level tax, or excludes the income the entity already paid tax on, so the state collects roughly the same total. The federal saving is the owner's marginal federal rate multiplied by the state tax that is now deductible instead of capped.
03The eight variables that differ by state
| Variable | What to check | Why it matters |
|---|---|---|
| Eligible entities and owners | Partnerships and S corporations are typical. Some states exclude entities with partnership, corporate, or trust owners; disregarded single-member LLCs are generally out. | An otherwise attractive election can be unavailable because of one owner's entity type. |
| Election timing | Annual or binding for several years; made on the return or by a date during the year; some states require an estimated payment by a mid-year date for the election to be valid. | A late or unfunded election is no election. Calendar the state's specific trigger. |
| Rate | Flat statutory rate, the state's top individual rate, or graduated brackets applied at the entity level. | The rate sets both the federal deduction and the owner credit; a flat rate above an owner's actual bracket can over-pay unless the excess credit is refundable. |
| Owner relief | Refundable or nonrefundable credit, exclusion of the taxed income, or both; carryforward period for unused credit. | Nonrefundable credits with no carryforward can strand tax for owners with losses or low state liability. |
| Nonresident owners | Whether the PTE tax replaces nonresident withholding or composite filing; whether the owner's home state gives a resident credit for PTE tax paid elsewhere. | A home state that denies the credit can leave a nonresident owner double-taxed, wiping out the federal saving. |
| Consent | Unanimous owner consent, majority, or a decision by the managing member or officer. | Governs whether a minority owner who is hurt by the election can block it. |
| Estimated payments and penalties | Separate entity-level estimate schedule; penalties for underpayment; whether the payment must be made in the tax year to be deductible by a cash-basis entity. | For federal purposes the deduction falls in the year paid for cash-method entities, so a December payment and a January payment land in different years. |
| Sunset provisions | Whether the state's PTE tax expires on a fixed date or automatically ends if the federal SALT cap is repealed. | Several regimes were written to disappear with the cap. Multi-year planning must account for that. |
04Who benefits, and who may not
- Resident owners in high-tax states with positive income benefit most.Their state tax is large, fully creditable at home, and newly deductible at the federal level.
- Nonresident owners need a two-state check.The election saves federal tax only if the owner's home state credits the PTE tax paid to the entity's state. Where it does not, or credits it only partially, the owner can end up worse off. Run the numbers for each nonresident before the entity elects.
- Owners with losses or low state liability may strand credits.If the owner's state credit is nonrefundable and exceeds their liability, the carryforward rules decide whether the value is deferred or lost.
- S corporations should check the pro-rata question.Entity payments made on behalf of shareholders are generally treated as distributions. Confirm how the state and the entity's governing documents handle a shareholder who opts out or whose share of the tax differs, to avoid stressing the single-class-of-stock requirement.
- Owners subject to the phase-down, or planning for 2030.With the federal cap phasing down above $500,000 of income and reverting in 2030, higher-income owners see the full benefit now, and every owner will again after the reversion unless Congress acts.
05A research workflow for one entity
- List every state where the entity files and every state where an owner resides.The election is made per entity state, but the benefit is realized per owner state.
- For each entity state, pull the statute and the department's PTE guidance.Confirm eligibility, the election mechanism and deadline, the rate, and the estimated payment rules. Form instructions are usually the fastest route to the practical deadlines.
- For each owner state, confirm the resident credit rule for PTE taxes paid to other states.This is where the analysis most often fails, and it is a state-specific question with a state-specific answer.
- Model the owners individually.Federal saving, state effect, and stranded-credit risk differ owner by owner. The election is right for the entity only if it is right, or at least neutral, for the owners who must consent.
- Calendar the payment dates.Both the state's validity requirements and the federal year-of-deduction rule depend on when cash actually moves.
06Compare states side by side
The State Tax Matrix includes the partnership PTE tax rate and the PTE election deadline for each state, alongside filing forms, due dates, nonresident withholding, and composite return rules, with every cell cited to the state's own authority. Pick the states your clients touch and read the differences in one table. For the questions a table cannot hold ("does this owner's home state credit PTE tax paid to that state?"), the AI Tax Assistant answers from the state statutes and guidance with a citation on every claim.
Try it free at partnertax.ai, no credit card required.
