What is the pass-through entity tax and does it help me?

The pass-through entity tax lets a partnership or S corporation pay state income tax at the entity level, so the business deducts it federally instead of the owner hitting the capped deduction for state and local taxes on a personal return. Owners then receive a credit against their state tax. Whether it helps depends on your state, your income, and your other deductions.

For tax year 2025

$40,000 ($20,000 married filing separately) (SALT deduction limit, 2025)
$500,000 ($250,000 married filing separately) (SALT phase-down MAGI, 2025)
$10,000 ($5,000 married filing separately) (SALT reduced-but-not-below floor, 2025)

Key points

The pass-through entity tax, or PTET, lets a partnership or S corporation pay state income tax at the entity level and deduct it federally.
The deduction taken by the entity bypasses the individual cap on state and local tax deductions that applies on an owner's personal return.
Owners receive a state credit or income exclusion for the tax the entity paid, so the state income tax is collected only once.
The One Big Beautiful Bill Act raised the individual state and local tax deduction cap and added a phase-down at higher incomes.
The election gives nothing to owners in a state with no income tax and can leave nonresident or multi-state owners worse off.

How does the pass-through entity tax work?

State income tax paid personally by an owner is an itemized deduction subject to the individual cap in IRC §164(b)(6). Above that cap the tax produces no federal benefit. After IRS Notice 2020-75 confirmed that a state income tax imposed on and paid by a partnership or S corporation is deductible by the entity, most states with an income tax enacted an elective entity-level tax.

The mechanism has three steps. The entity elects into the state's PTET and pays the owners' state income tax on the business profit. The entity deducts that payment as a business expense on Form 1065 or Form 1120-S, reducing the income that flows through to the owners' federal returns. Each owner then claims a credit on the state return, or excludes the taxed income, so the state collects the tax only once.

Who benefits from the election?

The election helps an owner whose state income tax on business profit, combined with property and other state taxes, exceeds what can be deducted personally under the current individual cap. After the One Big Beautiful Bill Act raised the cap and added a phase-down for higher incomes, the benefit narrowed for some middle-income owners and remained significant for owners whose income places them in the phase-down range, where the cap falls back toward its prior level.

Owners in high-tax states with substantial pass-through profit, such as physicians, attorneys, and professional practice partners, are the typical beneficiaries. Because the individual cap and phase-down changed for the current year, last year's conclusion should be re-modeled rather than carried forward.

What does the election require in practice?

Each state sets its own rules. The election is usually made annually on the entity return or through a separate filing by a fixed date, and many states require estimated PTET payments during the year, with a late election or missed estimates disqualifying the deduction for that year. Some states require the consent of every owner; others allow the entity to elect on behalf of all owners.

The credit mechanics also vary. Some states give owners a full credit, some a partial credit, and some exclude the income instead. The federal deduction lands in the year the entity pays, so cash-basis timing matters, and the CPA preparing the entity return coordinates the state election, the estimated payments, and the owner-level credits.

When does the pass-through entity tax not help?

Owners in a state without an income tax get nothing, because there is no state tax to move to the entity. Owners whose total state and local taxes fall under the current individual cap gain little or nothing, since they could already deduct the tax personally. Sole proprietors and single-member LLCs reporting on Schedule C generally cannot elect, because there is no separate pass-through entity to pay the tax.

Nonresident owners and owners with income in several states can end up worse off when their home state does not credit the PTET paid to another state. Since the election binds every owner of the entity in most states, the outcome should be modeled owner by owner before the deadline, and one owner's benefit should not be assumed to hold for the rest.