A pass-through entity tax is a state-level workaround to the federal cap on state and local tax deductions. Instead of the owners paying state income tax personally (where the SALT cap limits the federal deduction), the S corporation or partnership elects to pay the state tax at the entity level. The entity deducts that payment as a business expense, reducing the federal income that flows through to owners, and the owners receive a state credit or income exclusion so the same tax is not paid twice. The IRS blessed this structure in Notice 2020-75, and the large majority of states with an income tax have enacted a PTET regime. Elections are annual in most states, deadlines and estimated payment rules vary widely, and the math should be checked for owners in multiple states or with losses.
Pass-Through Entity Tax (PTET)
Primary authority: IRS Notice 2020-75
The authority behind it
IRS Notice 2020-75
Every entry in this glossary cites the statute, regulation, or IRS guidance behind it.
Worked example
A California S corporation with $1,000,000 of income elects PTET and pays $93,000 of state tax at the entity level. That $93,000 becomes a federal deduction, saving the owner roughly $34,000 of federal tax that the SALT cap would otherwise have disallowed, while California credits the payment against the owner's personal tax.
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Related terms
SALT Cap
The SALT cap limits the itemized deduction for state and local taxes income, sales, and property taxes combined.
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S Corporation
An S corporation is a corporation or an LLC that elects corporate treatment that has filed a valid election under...
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Partnership
A partnership is a business with two or more owners that is taxed under Subchapter K of the Internal Revenue Code.
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