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State Passthrough Entity Taxes and Federal SALT Cap Considerations

April 6, 2022, 8:45 AM

The state and local tax, or SALT, deduction limitation for individuals has caused many states to implement a workaround for their passthrough entities. Sixteen states have these programs effective for tax year 2021, six others are effective beginning in tax year 2022, and seven more states are considering the move. Although participation may be advantageous for many, several factors can determine if opting in is beneficial.


The Tax Cuts and Jobs Act, or TCJA, added IRC Section 164(b)(6) to impose a $10,000 limitation on the SALT deduction for individuals who itemize deductions on their federal income tax return, more commonly known as the SALT cap. The SALT cap applies to taxable years beginning after Dec. 31, 2017, and before Jan. 1, 2026. While the TCJA did not impose a similar cap on business-related state and local taxes incurred by businesses, state and local income taxes resulting from passthrough entities are still included in this individual-level limitation.

In response, many states have enacted mandatory or elective regimes allowing passthrough entities to calculate and pay tax at the entity level—referred to as passthrough entity tax, or PTET, programs. The entity receives a non-separately stated deduction at the federal level, and generally, there will be a corresponding or offsetting state-level credit, deduction, or exclusion for the passthrough entity owner. The intention of these workaround programs is to mitigate the effect of the federal SALT cap for individual owners of passthrough entities.

Considerations for Electing In

Although a few states, like Connecticut, have enacted a mandatory PTET, most states allow some or all of the passthrough entity owners to elect the PTET. These elections involve a number of considerations, including:

  • Timing of the election;
  • Whether the election impacts all or only a portion of the passthrough entity owners;
  • How it impacts the tax filings and payments; and
  • Whether the PTET election is an annual election or whether it is binding for future years.

Once these program basics are understood, a key factor is if there are owners residing in different states. In some cases, a resident state may not allow an owner of a passthrough entity to claim a credit for PTET paid to other states. In this case, there could be adverse tax consequences to the owner, as the cost of losing the credit for taxes paid to other states on the owner’s individual income tax return can quickly offset any federal tax benefit of the PTET deduction.

S Corporation Consideration

Where a state PTET program allows for an election to participate by owner, rather than mandating an all-or-nothing approach, an issue could arise for S corporations. If not all shareholders participate in the program, could inequities and disproportionate distributions occur? The issue has not yet been resolved in IRS guidance, but the AICPA has suggested that PTET payments follow composite payment deemed distribution treatment under Treas. Reg. Section 1.1361-1(l)(2)(ii). Further clarification is expected in forthcoming regulations.

Timing of Deductibility

The IRS seemingly blessed the PTET workaround in Notice 2020-75, clarifying that partnerships and S corporations may deduct state and local tax payments at the federal entity level in computing non-separately stated taxable income or loss. Even though Section 164(a) provides a SALT deduction is allowed for the tax year in which the taxes are “paid or accrued,” there is still a hurdle for accrual basis taxpayers that would postpone a tax deduction into the year after the election.

In the notice, the IRS indicated that a deductible SALT tax payment is one that the passthrough entity makes during a taxable year, stating, “The partnership or S corporation is allowed a deduction…in computing its taxable income for the taxable year in which the payment is made.”

As mentioned, states may have differing PTET program rules, and where a state’s PTET is not mandatory, an election is required to participate. Under these elections, a taxpayer will typically make the election with a timely filed tax return. Thus, the elections and related payments are not made until after the end of the tax year, which may lead to a deduction for the SALT entity-level payment also in that later year.

However, questions have arisen whether the PTET payment deduction could rely on the “paid or accrued” language of IRC Section 164(a), as well as other relevant provisions, and deduct accrued payments in the year to which they relate. If a business wishes to explore this option, it’s important to understand this position is in contrast to the language of Notice 2020-75. At a minimum, Section 451 and the all-events test would need to be met to deduct an accrued payment in the tax year. Taxpayers may consider disclosing such a position pending future guidance from Treasury and the IRS.


The variation in state PTET programs and the facts and circumstances of each passthrough entity’s owners must be appropriately weighed in order to make informed decisions about PTET elections. It’s important to understand and communicate potential tax consequences for the passthrough entity as well as for each owner.

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   

Jeff Schuetz is a partner in RubinBrown’s State and Local Tax Services group and a member of RubinBrown’s Construction Services and Manufacturing & Distribution Services groups. Additionally, Jeff offers tax consulting and planning services to the firm’s clients.

Rhonda Sparlin serves as the partner-in-charge of the State and Local Tax Services group at RubinBrown. Rhonda advises businesses on issues related to multistate income, franchise, and indirect tax issues. 

Amie Kuntz is a member of RubinBrown’s National Tax group. She provides diverse tax consulting to privately held organizations and high net worth individuals, as well as monitors and analyzes current tax legislation and guidance.  

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