Trap 12 · The SALT cap · From Chapter 9
State PTET Elections: Dodging the SALT Cap
A pass-through entity tax election moves state income tax from the shareholder's capped SALT deduction to the S-corp's deductible business tax — the entity pays, the entity deducts, and the owner claims a state credit or exclusion.
The cap
Section 164(b)(6) caps the individual state and local tax deduction at $10,000 — $5,000 for married filing separately — pushing high-tax-state owners over the limit. Every dollar above the cap is a lost federal deduction.
The workaround
Electing states impose an entity-level tax the S-corp pays and deducts as an ordinary business expense, outside the individual cap — blessed by IRS Notice 2020-75. The shareholder then gets a state credit or exclusion so the same income is not taxed twice.
The election mechanics
Each state sets its own consent, timing, and payment rules — some bind all owners, some need unanimous consent, and estimated-payment deadlines vary. Model the election yearly with reasonable compensation set first, since wages change the passthrough base — and revisit distributions vs salary before moving cash.
Trap questions, answered
- How does a PTET election save federal tax?
- The S-corp deducts state tax as a business expense instead of the owner claiming it under the capped individual SALT deduction.
- Does every state offer a PTET election?
- No — most income-tax states do, but each sets its own consent, timing, and payment rules, and a few states have no regime at all.
- Do owners still owe state tax after the election?
- Usually the owner gets a state credit or exclusion for the entity-paid tax, but the mechanics differ by state — confirm the return before assuming full relief.
The law: 26 U.S.C. §164 · Full Ch. 9 summary
The other traps: Reasonable Compensation · Distributions vs Salary · Terminating the S Election · QSUB Election