The federal cap on the state and local tax (SALT) deduction — raised by OBBBA to $40,000, and itself phasing down for incomes above $500,000 — leaves owners in high-tax states deducting only a fraction of the state income tax they actually pay. The pass-through entity tax (PTET) is the legislatively sanctioned way around it, and for an eligible owner in a high-tax state it is close to mandatory.
The mechanism is a reassignment of who pays the tax. A partnership or S-corporation elects to pay state income tax at the entity level rather than passing the liability through to the owners’ personal returns. Because the entity pays it, the payment is the entity’s deductible expense ( IRC §164, “Taxes”), and it reduces the business income flowing through to the owners’ K-1s — a full federal deduction for state income tax, taken above the individual SALT cap entirely. The owners then claim a credit (or an income exclusion) on their state returns for the tax the entity already paid. The IRS blessed the structure in Notice 2020-75, and roughly three dozen states now offer some form of it.
Two practical notes. First, treat the details as state-specific and time-sensitive: PTET regimes were enacted on staggered schedules and some carry sunset dates — California’s elective tax, for one, was written to expire after the 2025 tax year absent extension — so confirm your state’s current-year rules and election deadline rather than assuming. Second, an early version of OBBBA would have denied the PTET deduction to service businesses; the enacted law did not, so the workaround remains available across business types. Where it is offered and you qualify, electing in is one of the highest-return administrative steps available to a business owner.