PTE stands for Pass Through Entity tax. It is a tax specifically for pass-through entities such as S-Corps, partnerships, and limited liability companies (LLCs). It's important to note that PTE is enacted and controlled at the state-level. And it's main purpose is to provide pass-through entities with a workaround for the SALT cap.
As of early March 2023, 30 states and 1 locality have PTE taxes. Terms do vary a lot by state, which can complicate matters for businesses who operate in multiple states.
SALT Cap Workaround
First of all, what is the SALT cap? SALT is the acronym for state and local tax. Back in 2017, the federal government's Tax Cuts and Jobs Act enacted a $10,000 cap on the state and local taxes that can be deducted on federal returns.
This cap is only for individual tax filers, including both those with and without pass-through entities. Prior to 2017, there was no limit.
C corporations are unaffected, and still have no cap on their SALT deductions.
The SALT cap was a major change in tax policy that affected a lot of people. It was especially felt by those who work in high-tax states and pay a lot of property taxes. Changes in tax laws can ruin your life if you're not careful. That's why I recommend staying on top of tax policy changes.
Some attempted state workarounds to the SALT cap were disallowed by the US Treasury Department. But, the IRS did allow states the option to offer PTE tax “benefits” for tax filers with pass-through entities.
Related reading: How To Pay Little To No Taxes For The Rest Of Your Life
How Does PTE Tax Work?
I'm going to use a simple California S-Corp as an example to explain how PTE tax works. A small business owner named Sarah has a pass-through entity, Sara's Sandwiches, that is an S-Corp. She is the sole owner and shareholder.
When Sarah files her business returns, she doesn't pay any corporate federal taxes, and only pays a relatively small amount of California corporate state tax.
Since her S-Corp is a pass-through entity, the income from her business is included on her personal tax returns. In other words, her business' income passes through as personal income.
In California, Sarah elects to participate in PTE each year through 2025. Essentially what this does is Sarah's business pays PTE tax up-front (9.3% on her business pass-through profits), which gets deducted on her individual federal return. And, the PTE tax her business paid up-front is used like a credit to offset her personal state tax liability.
Simple PTE Tax Example
Let's look further at Sarah's tax benefit of electing and paying PTE tax in California. Let's say her business's qualified net income is $1,000,000. In California, PTE is 9.3% of qualified net income, so $1,000,000 x 9.3% = $93,000.
When she goes to file her personal federal return, notice the difference in her pass through income. It's $93,000 less when she elects and pays PTE tax to California. Assuming $125,000 in salary and taking the standard deduction, she winds up owing $37,944 less in federal taxes. That's quite a savings!
Are PTE Tax And State Tax The Same Thing?
No, PTE tax and state income tax are two separate types of taxes.
PTE tax is imposed on the income earned by pass-through entities such as partnerships, LLCs, and S-corporations. It is calculated based on the entity's net income or loss. And it's generally paid by the entity itself, rather than by the individual owners or shareholders.
State income tax, on the other hand, is a tax imposed by the state government on the income earned by individuals and corporations. The specific rules and rates for state income tax vary by state.
While there may be some similarities between PTE tax and state income tax, they are not the same thing. PTE tax is a tax on the income earned by the pass-through entity itself, while state income tax is a tax on the income earned by individuals or corporations.
Related reading: What’s The Right Ratio Between Salary And Distribution To Save On Taxes?
Does PTE Tax Lower The Filer's Personal State Tax Due?
PTE (Pass-through Entity) tax payments made by a pass-through entity do not directly lower the California personal state tax due of individual filers.
However, the income or loss that flows through to the individual owners or shareholders of the pass-through entity may be used to offset the filer's personal state tax liability, depending on the specific circumstances and applicable tax laws.
Keep in mind the tax treatment of pass-through entities and the resulting impact on personal state tax liability can be complex.
Which States Offer PTE Tax Elections?
As mentioned earlier, there are 30 states and 1 locality that have PTE taxes as of March 2023. They are:
- Alabama
- Arkansas
- Arizona
- California
- Colorado
- Connecticut
- Georgia
- Idaho
- Illinois
- Indiana
- Kansas
- Louisiana
- Massachusetts
- Michigan
- Maryland
- Minnesota
- Montana
- Missouri
- North Carolina
- New Jersey
- New Mexico
- New York
- New York City
- Ohio
- Oklahoma
- Oregon
- Rhode Island
- South Carolina
- Utah
- Virginia
- Wisconsin
Here's a map of the states that have PTE Tax:
PTE Tax is definitely worth looking into if you have pass-through entity income. Keep in mind you have to manually elect to participate each year. And the last tax year to participate as of now is 2025.
Another item to discuss with your accountant is if you should make all payments within the calendar year to get the most benefit for that tax year. Or if you should just pay by the payment deadline.
Remember, rules vary a lot from one state to the next, and from one pass-through entity to the next. Good luck, and I hope you can get some tax savings!
Disclaimer: This article is informational to the best of our knowledge and is not intended as tax advice. Please consult with a tax professional for advice on your particular situation.