Bloomberg Tax
Free Newsletter Sign Up
Bloomberg Tax
Advanced Search Go
Free Newsletter Sign Up

SALT Cap Workaround: Pass-Through Entity Tax Update, Part I

Feb. 8, 2022, 9:45 AM

Pass-through business owners in a growing number of states may take advantage of entity-level state tax elections as a measure of relief from the $10,000 federal deduction limit for state and local taxes—the SALT cap, which was introduced under the 2017 Tax Cuts and Jobs Act, or TCJA.

The trend among states to adopt elective pass-through entity taxes, or PTETs, emerged as a measure to decrease the impact of the SALT cap. Until recently, state legislative strategies to allow individual taxpayers to bypass the cap have been summarily rejected by the IRS and Treasury. In addition, a decision by the U.S. Court of Appeals for the Second Circuit, New York v. Yellen, blessing the SALT cap in October appeared to foreclose a judicial repeal of the SALT Cap over constitutional claims, although four states have recently requested U.S. Supreme Court review of the decision.

IRS guidance released late last year, in IRS Notice 2020-75, permitted state PTETs as a workaround to the SALT cap for individual taxpayers who own pass-through businesses such as partnerships, S corporations, and some LLCs. In general, PTETs allow a pass-through entity to pay state-level taxes on business income—and claim a corresponding federal deduction—which in turn permits individual shareholders to maximize their eligible deductions subject to the SALT cap. At least 22 states have already adopted workarounds and we expect for several more to follow the trend and adopt similar legislation.

Federal lawmakers continue to vigorously debate the future of the SALT cap, which is set to sunset at the end of 2025. If the SALT cap is extended, taxpayers operating in states with workarounds may realize significant benefits, together with new administrative burden, from electing entity-level taxes. In particular, taxpayers should be mindful of state complexities in administering new workaround structures, wide variation among states offering elections, and the risk that some nonresident areas, such as Maryland and Washington, D.C., may not credit payments made under another state’s PTET.

PTET as a Workaround to the SALT Cap

Under the TCJA, the SALT cap imposes a $10,000 limit for federal deductions allowed on individual taxpayer returns for state and local taxes. The cap is not applicable to C corporations or other business entities, which means that it particularly impacts pass-through business entities and their individual shareholders.

Pass-through entities are typically taxed at the state level in the same way as at the federal level. Income and resulting tax liability flow through to individual owners, members, or shareholders. Under the SALT cap, owners of pass-through entities may be liable for state and local taxes in every state where their business derives income but may only claim a federal deduction for up to $10,000 of all such state-level taxes paid.

In states that have PTET legislation, a pass-through entity elects to pay state-level taxes at the entity level, rather than passing on the full tax liability to individual owners, with state tax credit to individual owners for state taxes paid by the entity. The entity, which is not subject to the SALT cap, may claim a federal Section 164 business expense deduction, and shareholders may claim deductions for up to $10,000 for other state taxes paid on their individual returns, such as residential property taxes or state income taxes on other sources of income.

Connecticut was the first state to adopt a workaround, followed by Wisconsin, Oklahoma, Rhode Island, New Jersey, Louisiana, and Maryland. Many more states moved to adopt SALT cap workarounds following IRS guidance released in November 2020, which blessed the PTET structure: Alabama, Arkansas, New York, Idaho, South Carolina, Georgia, Colorado, California, Arizona, Oregon, Minnesota, Massachusetts, Illinois, Ohio, and Michigan. More states are expected to propose and/or adopt legislation, including Pennsylvania and North Carolina.

California and New York Considerations for PTET Elections

The PTET provisions in California and New York generally follow the standard SALT cap workaround formula: A small business may elect to pay tax at the entity level, and a corresponding credit is allowed at the partner, member, or shareholder level. Important differences between the two state programs highlight the lack of uniformity and potential planning pitfalls for taxpayers.

California’s PTET allows certain pass-through entities to elect to pay a “net tax” equal to 9.3% of distributive shares of California-source income of each consenting partner, member, or shareholder. The election is not available to pass-through entities that are disregarded for federal tax purposes, have owners that are partnerships, are part of a combined group, or are publicly traded. Each qualified owner separately elects to be subject to the PTET. If an owner elects not to be included, the qualifying entity can still elect to pay the PTET for other owners. Only the distributive share income of consenting partners, members, or shareholders, however, is included and subject to the net tax rate, and only these consenting taxpayers are eligible for corresponding credits on their respective individual state returns. The elective tax is set to expire concurrently with expiration of the SALT cap as enacted under the TCJA. The election can only be made on an original, timely filed return due on or before March 15 for the previous tax year.

New York’s PTET allows any entity classified as an S-corporation or a non-publicly traded partnership for federal and state purposes to elect to pay an entity-level state tax on income at graduated rates that correspond to state personal income tax rates. The election is not applicable to sole proprietors or disregarded single-member LLCs. An entity’s election to pay the tax is irrevocable for all partners, members, or shareholders for all four estimated payments due following the annual election. Calculation of taxable income differs between S-corporations and partnerships:

Electing New York S-corporations pay entity-level taxes on all income apportioned to New York. Electing New York partnerships pay entity-level taxes on the entire distributive shares to resident partners, plus the New York-source partnership income of nonresident partners.

Unlike California, which excludes nonconsenting partner income from the elective PTET, all state pass-through income is included in computing New York taxable income for an electing entity. A corresponding credit is issued to all direct partners, members, or shareholders in proportion to their respective ownership. Separately, a credit against personal income tax for certain similar entity-level tax paid to other states is provided to direct partners, members, or shareholders who are residents of New York. The elective tax does not have an expiration date concurrent with the sunset of the federal SALT cap. The period to opt-in to the New York PTET has ended for tax year 2021, but for tax years 2022 and later, an eligible entity may opt in on or after Jan. 1 but no later than March 15 of the tax year—i.e., by March 15, 2022, for the 2022 tax year.

In the second part of this article, we will discuss important considerations for deciding whether to make the PTET election in a given state, provide an update on federal proposals to increase or eliminate the SALT cap, and summarize states’ efforts to eliminate the SALT cap at the U.S. Supreme Court.

This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

William Gorrod is a partner at Baker Botts’ San Francisco office, where he focuses on state and local tax planning, compliance, and corporate transactions on a multistate basis. He also represents clients in state and local tax controversies throughout the United States.

Renn Neilson is partner at Baker Botts’ Houston office, where he is the firmwide chair of the state and local tax section and a member of the oil and gas M&A team. His practice focuses on state and local taxation, incentives, and unclaimed property.

Matthew Larsen is a partner at Baker Botts’ Dallas office, where he represents clients in state and local tax planning, controversies, incentives and legislation in Texas and numerous other states. He assists clients in structuring operations and transactions to reduce state and local taxes and advises on real estate transactions, asset and stock sales, mergers, service transactions, and development projects.

Jon Feldhammer is a partner at Baker Botts’ San Francisco office. He is a former IRS senior trial attorney and works on complex tax controversies for clients before the IRS, California Franchise Tax Board and other state agencies. He advises clients on tax compliance issues and assists corporations, partnerships and individuals in navigating the challenging tax environments.

Ali Foyt is an associate at Baker Botts’ Houston office, where she advises and represents clients in a broad range of planning and controversy matters related to state and local taxes around the country. She regularly defends taxpayers in tax controversy and assists clients with property tax incentive negotiations and strategic multistate planning.

We’d love to hear your smart, original take: Write for Us

To contact the reporter on this story: Melanie Cohen at

To contact the editor responsible for this story: Kelly Phillips Erb at