What Is Pass-Through Entity Tax (PTET)?

A Pass-Through Entity Tax (PTET) is an income tax levied at the business level on pass-through entities such as partnerships and S corporations. This tax is designed to provide a federal deduction for state and local taxes paid by the entity, which reduces the income passed through to individual owners. The approach is supported by IRS Notice 2020-75, which confirms that specified income taxes paid by pass-through entities are deductible when calculating the entity’s federal taxable income. States that offer PTET generally provide a credit or income exclusion to the owners, preventing double taxation at both the entity and personal levels.

Key Takeaways

• PTET shifts state income tax liability from the individual to the entity, allowing a federal deduction not limited by the $10,000 SALT cap.
• Most PTET programs are elective, though rules vary by state in terms of eligibility, rates, and election deadlines.
• Owners typically receive a state tax credit or income exclusion to offset the entity-level tax paid.
• Multi-state businesses must consider how residency rules, credit mechanisms, and sourcing affect overall tax benefits.
• PTET laws and benefits may change as state and federal tax rules evolve.

Why PTET Exists

The PTET concept emerged in response to the Tax Cuts and Jobs Act of 2017, which capped the itemized deduction for state and local taxes (SALT) at $10,000 for individuals. By paying the tax at the entity level, pass-through businesses can deduct the full amount on their federal return, effectively sidestepping the cap for their owners.

Connecticut was the first state to adopt a PTET in 2018, initially as a mandatory system. Over time, other states followed with elective versions, and Connecticut later shifted to an elective model in 2024. The IRS formally acknowledged and permitted this structure through Notice 2020-75.

Where PTET Is Available

As of 2025, over 30 states and one locality have enacted PTET regimes. These programs vary significantly: some apply a flat rate, others use graduated rates, and each state has unique definitions for eligible entities, filing requirements, and credit structures. Many states continue to refine their PTET laws, adjusting rates, eligibility, and administrative procedures.

How PTET Works

When a pass-through business elects PTET, the entity pays state income tax directly on its net income. The payment is deductible for federal purposes at the entity level, lowering the taxable income passed through to owners.

Owners then typically receive one of two benefits at the state level:

• A tax credit equal to their share of the PTET paid, offsetting their personal state income tax liability.
• An income exclusion for the portion of income already taxed at the entity level.

Elections are generally made annually and are often irrevocable for the year. Deadlines vary: some states require the election early in the tax year, while others allow it on the annual return.

Eligible Entities and Owners

Most PTET programs cover partnerships, multi-member LLCs taxed as partnerships, and S corporations. Sole proprietorships and single-member LLCs that are disregarded entities are not eligible.

Some states require all owners to consent to the election, while others allow a majority vote or manager decision. In certain cases, tiered partnerships or entities with out-of-state owners may face additional restrictions.

Federal Tax Treatment

Under IRS Notice 2020-75, PTET payments are deductible in arriving at the entity’s non-separately stated taxable income. This deduction reduces the income that appears on each owner’s Schedule K-1. Because it is an entity-level expense, it is not subject to the individual SALT deduction limit.

However, the deduction may affect other federal calculations, such as the Qualified Business Income (QBI) deduction, since it changes the amount of income allocated to owners. The impact depends on each taxpayer’s specific situation.

Compliance and Planning Considerations

PTET can provide meaningful federal tax savings, but the benefits depend on the owners’ residency, state credit rules, and how much state tax is due. Businesses should model:

• The federal tax savings from the entity-level deduction.
• The value of state tax credits or income exclusions.
• Whether nonresident owners can fully use the credits in their home states.

Other considerations include estimated payment schedules, cash flow needs, and the administrative burden of separate PTET filings. Multi-state entities must also examine whether other states grant credit for PTET paid elsewhere.

Recent Legislative Developments

While PTET has been widely adopted, it remains subject to change. Federal proposals have surfaced both to preserve and to limit the benefits of PTET. State legislatures continue to refine programs to address technical issues and close unintended gaps. Staying current on legislative updates is essential for taxpayers considering PTET elections.

When PTET May Be Advantageous

PTET elections often benefit profitable businesses with owners who are subject to high state income taxes and limited by the SALT cap. The advantage diminishes if the state credit is partial, if owners cannot fully utilize it, or if the administrative complexity outweighs the potential tax savings.

The Bottom Line

A Pass-Through Entity Tax can be a valuable tool for partnerships and S corporations to preserve federal deductibility of state income taxes despite the individual SALT cap. It works best in states with favorable credit rules, high state tax liabilities, and clear administrative processes. Because rules vary widely and continue to evolve, business owners should consult tax professionals and model potential outcomes before making an election each year.