Defeat the SALT Cap with the PTE Tax – Part 2

Overview

In Part 1, we explained how PTE owners can reduce federal taxable income by having their pass-through entity pay state income taxes at the entity level.

Under this approach:

  • The PTE deducts state income taxes as a federal business expense, which bypasses the federal SALT deduction limit.
  • PTE owners either receive a state tax credit or have their PTE income excluded for state purposes.
  • The result is a full or near-full deduction on federal returns for state income taxes attributable to PTE income.

Part 2 focuses on practical guidance, including state variations, eligibility, deadlines, and handling non-resident owners.

States That Have Enacted PTE Taxes

Currently, 29 states have PTE tax legislation, all elective except Connecticut (mandatory). States with enacted PTE taxes include:

  • Alabama, Arizona, Arkansas, California, Colorado, Connecticut, Georgia, Idaho, Illinois, Kansas, Louisiana, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, New Jersey, New Mexico, New York, North Carolina, Ohio, Oklahoma, Oregon, Rhode Island, South Carolina, Utah, Virginia, Wisconsin

Legislation is pending in Iowa, Pennsylvania, and Vermont.

Important: Each state’s PTE rules vary. Carefully review your state’s guidance before making an election.

Eligibility for the PTE Election

  • Eligible entities: Partnerships, multi-member LLCs taxed as partnerships, and S corporations.
  • Ineligible: Sole proprietors and single-member LLCs taxed as disregarded entities.
  • Special cases: In California, a single-member LLC that is a partner or shareholder of a PTE may make a PTE election.
  • Most states exclude publicly traded partnerships and non-individual owners, as well as tiered PTEs (PTEs owned by other PTEs).

Ownership Requirements

  • Most states require all owners to participate in the election.
  • Some states, like Arizona and California, allow owner-by-owner elections.
  • Review your partnership agreement, operating agreement, or S corporation bylaws to ensure the election is permissible.
  • Providing PTE credits to some owners but not others may violate S corporation rules (one-class-of-stock requirement).
  • States generally require notice to owners, often via the state K-1.

PTE Election Deadlines

  • Most states require elections by the original or extended due date of the entity’s tax return.
  • Some states require a specific election form, while others allow checking a box on the regular return.
  • Elections are typically annual and irrevocable for the year of election.
  • Carefully track deadlines to ensure eligibility and compliance.

Estimated PTE Taxes

  • Most states require estimated PTE tax payments during the tax year.
  • Payments often follow the schedule for regular estimated taxes, typically quarterly.
  • Some states have unique requirements. For example, California requires a single estimated PTE tax payment equal to the greater of $1,000 or 50% of the prior year’s liability, due mid-year.
  • Missing estimated payments can prevent the PTE election for that year.

PTE Tax Rates

  • PTE tax rates differ by state:
    • Flat rates
    • Graduated rates
    • Top individual income tax rates

For example, California’s PTE tax is 9.3%, below the state’s top income tax rate of 13.3%.

PTE Credit vs. Exclusion

  • Credit states: Owners claim a credit for their distributive share of PTE taxes.
  • Exclusion states: Owners exclude their share of PTE income from state taxable income.
  • Partial credits may exist (e.g., Connecticut, Massachusetts).
  • Non-refundable credits may carry forward.
  • Exclusion ensures owners’ state taxable income is reduced by the PTE tax.

Non-Resident PTE Owners

  • Non-resident owners usually claim credit only for income sourced to the state.
  • Some states require non-residents to file returns if they exceed thresholds.
  • Non-resident withholding may be required.
  • Some states allow credit on the resident state return for taxes paid to another state, if substantially similar.
  • Where credits are not allowed, non-resident owners may face higher state taxes, potentially reducing net benefit.

PTE Election Decision Path

StepQuestionAction
1Is your business a pass-through entity (Partnership, Multi-member LLC, or S Corporation)?Yes: Continue to Step 2. No: PTE election not available.
2Does your state allow a PTE tax election?Yes: Continue to Step 3. No: PTE election not available.
3Do you want to bypass the federal SALT deduction cap or reduce federal taxable income?Yes: Consider PTE election. No: Election optional; may still benefit non-itemizers.
4Does your state provide an Owner Exclusion or Owner Credit?Exclusion: Owners exclude PTE income from state return. Credit: Owners report income but take credit for PTE tax paid.
5Will QBI deduction reduction impact federal tax?Yes: Model impact. PTE election may still be beneficial. No: Proceed with election.
6Make PTE election with your stateSubmit election before state deadline. Claim federal deduction at entity level.
7Report PTE income and deductionsEntity deducts state tax; owners reflect non-separately stated income on Schedule K-1.

Key Takeaways

  1. 29 states now allow PTE taxes, enabling owners to bypass the SALT cap by paying state taxes at the entity level.
  2. Only multi-owner PTEs taxed as partnerships or S corporations are eligible. Single-member LLCs and sole proprietors are excluded.
  3. Estimated taxes are required in most states before making the election.
  4. PTE owners receive credits or exclusions depending on state rules.

Non-resident owners may or may not receive credit in their home state, depending on local laws.

Confused about the SALT tax or PTE elections? Feel free to contact us for a consultation.