Beating the $10,000 SALT Cap with the PTE Tax
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.
What Is an Elective Pass-Through Entity Tax?
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.
Takeaways
PTE taxes are elective in all states except Connecticut, where they are mandatory. The rules vary from state to state. Your entity must make a PTE election and pay estimated state income taxes. It must meet specific deadlines.
The PTE’s deduction for state income taxes is not subject to the $10,000 SALT tax limit because it does not apply to taxes imposed at the business-entity level.
The IRS has issued a notice approving state PTE taxes.
The PTE election is available only to entities taxed as partnerships or S corporations. Sole proprietors and single-member LLCs don’t qualify.
Next month, we’ll publish Part 2 of this article, giving you more insights and covering more on how to make this work for you.
If you have any questions on the PTE or need my help, don’t hesitate to call me on my direct line at 509-543-7600 or send a request HERE.
September 2022
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