The PTE Tax Election: A Step-by-Step Guide to Bypassing the $10,000 SALT Cap

Bottom Line Up Front (BLUF):

The Pass-Through Entity (PTE) Tax is a state-level election that allows your S Corporation or Partnership to pay state income taxes on your behalf. This converts a limited personal deduction into a fully deductible business expense, effectively bypassing the federal $10,000 State and Local Tax (SALT) deduction cap and lowering your federal tax bill.

This is not a loophole; it is an IRS-approved strategy (Notice 2020-75) designed as a direct response to the Tax Cuts and Jobs Act of 2017. However, it is an optional, complex mechanism with state-specific rules.

This guide will walk you through the mechanics of the PTE tax election, showing you the before-and-after calculation and posing the key questions you must answer to determine if it is the right strategy for your business.

The Core Problem: The $10,000 SALT Cap

Before 2018, you could deduct all of your state and local taxes—including property and income taxes—on your federal return if you itemized. The Tax Cuts and Jobs Act (TCJA) changed this by introducing a $10,000 annual cap on the State and Local Tax (SALT) deduction for individuals.

For business owners in states with high income and property taxes, this cap meant a significant portion of their state tax payments no longer provided a federal tax benefit. For example, if you paid $50,000 in state income taxes and $15,000 in property taxes, your federal deduction was still limited to just $10,000. The remaining $55,000 was non-deductible at the federal level, creating significant "tax drag."

The System: A Step-by-Step Example of the PTE Tax Mechanism

The PTE tax election is a system designed to shift the state tax deduction from the limited personal side of your ledger to the unlimited business side. Let's walk through a practical example to see how the inputs and outputs work.

Scenario

Business: ABC Services, LLC (taxed as an S Corporation)
Owners: Two equal 50/50 partners, Alex and Ben.
Business Profit: $1,000,000
State: A high-tax state with a 9.3% PTE tax rate.
Federal Tax Rate: We'll assume a 32% marginal federal tax rate for both partners.

The "Before" Picture: No PTE Election

ABC Services earns $1,000,000 in profit.
The profit "passes through" to the owners. Alex and Ben each receive a Schedule K-1 showing $500,000 of income.
Each partner is personally responsible for paying state income tax on their $500,000 share. At a 9.3% rate, this is $46,500 each.
When filing their federal return, Alex and Ben can only deduct $10,000 of their state taxes. The remaining $36,500 of their state tax payment provides zero federal tax benefit.

The "After" Picture: The PTE Tax Mechanism

The system is engaged to convert the expense.

Total Savings: $29,760

The PTE Tax Mechanism in 5 Steps

Step 1: The Business Makes the Election

ABC Services files an election with the state to pay the PTE tax for the year. This is an active choice, not an automatic process.

Decision Point #1: Is my business eligible?

If/Then Logic: If your business is a Partnership, multi-member LLC, or S Corp, then you are generally eligible. C Corps and Sole Proprietorships are not.

Action: Confirm your state’s specific eligibility rules.

Step 2: The Business Pays the State Tax

ABC Services pays the state income tax directly from the business bank account. Calculation: $1,000,000 (Profit) x 9.3% (PTE Rate) = $93,000.

Decision Point #2: Can my business cash flow support this?

If/Then Logic: If you elect PTE, then the responsibility for estimated payments shifts from personal to business accounts.

Action: Review cash flow projections to ensure you can make these payments on time. This is a crucial operational shift.

Step 3: The Business Takes a Federal Deduction

The $93,000 tax payment is now an ordinary business expense. ABC Services deducts this on its federal return (Form 1120-S). New Taxable Profit: $1,000,000 - $93,000 = $907,000. This lower profit passes through to the owners on their K-1s.

Decision Point #3: Do I itemize my personal federal deductions?

If/Then Logic: If you take the standard deduction, then the primary benefit of the PTE election is lost.

Action: This is a hard filter. If you do not itemize, the PTE election likely provides no federal tax savings.

Step 4: Owners Receive a State Credit

To prevent double taxation, the state gives Alex and Ben a credit on their personal state tax returns for the tax the business already paid. Each partner receives a $46,500 credit, typically wiping out their state tax liability for this income.

Decision Point #4: Does my state use a credit or an income exclusion?

If/Then Logic: If your state provides a credit (most common), the mechanics work as shown. If it uses an income exclusion, the reporting is different but the result is similar.

Action: Understand your state's specific rules, as this affects non-resident owners.

Step 5: Calculating the Net Federal Tax Savings

The benefit comes from reducing federal taxable income.

Income Reduction per Partner: $500,000 (Before) - $453,500 (After) = $46,500
Federal Tax Savings per Partner: $46,500 x 32% = $14,880
Total Savings for the Business: $14,880 x 2 = $29,760

By using the PTE tax mechanism, the owners collectively saved nearly $30,000 in federal taxes. They successfully converted a non-deductible personal expense into a fully deductible business expense.

Critical Warnings & Nuances

The PTE tax is a powerful system, but it has strict operating parameters. Misunderstanding these rules can lead to costly errors.

Misconception 1: "The benefit is automatic for my S Corp."

Reality: The PTE tax is an opt-in system that requires a timely, formal election each year. Missing the deadline means forfeiting the benefit for that entire tax year.

Callout Box: Deadlines Are Absolute

Each state sets its own deadlines for making the PTE election and for paying the associated tax. Some require the election at the beginning of the tax year, while others allow it when the return is filed. Failure to comply with these strict timelines will nullify the strategy.

Misconception 2: "The rules I read online apply to my state."

Reality: State rules are not uniform. They vary dramatically on key details:

Tax Rates: PTE rates are not always the same as the top individual rate.
Tax Base: Some states tax all income, others only in-state sourced income.
Deadlines: Election and payment deadlines differ significantly.
Owner Treatment: The mechanism can be a credit or an income exclusion, which is critical for trusts or non-resident owners.

Nuance: The 2025 Sunset Provision

The federal $10,000 SALT cap that makes this strategy so valuable is scheduled to expire after 2025. If Congress does not extend it, the primary federal benefit of the PTE tax election will disappear, and the system may become obsolete.

The Solution: Is the PTE Tax System Right for You?

The example above illustrates the logic, but your potential benefit depends on your specific numbers. To determine if this strategy is right for you, you must answer the decision point questions from the walkthrough:

Is my business an eligible entity (Partnership, S Corp) in a state that offers a PTE tax?
Do I, as an owner, itemize my deductions on my federal tax return and consistently exceed the $10,000 SALT cap?
Does my business have the operational discipline and cash flow to manage estimated tax payments at the entity level?

If you answered "yes" to all three, you are a prime candidate for this strategy. The next step is to quantify the exact benefit. The calculation involves your specific business income, your state's PTE tax rate, and your marginal federal tax bracket.

PTE Tax Benefit Calculator

Estimate your potential federal tax savings.

To see how these mechanics impact your specific numbers and calculate your potential federal tax savings, use our PTE Tax Benefit Calculator above. It is designed to turn this complex system into a clear financial decision. From there, we can build a plan to make the election and manage the payments for maximum benefit.