Understanding Your State’s PTE Tax Rules

September 7, 2022
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The Tax Cuts and Jobs Act (TCJA) brought many significant tax law changes. Some were very beneficial to certain individuals and business owners. Other new tax rules were a bit more controversial. Perhaps the least popular change brought by the TCJA was a first-ever cap on the federal personal income tax deduction for state and local taxes.

From 2018 through 2025, the tax law caps itemized deductions for state income taxes (or general sales taxes if elected instead of income taxes), state real property taxes, and personal property taxes at $10,000. This is otherwise known as the “SALT cap.”

Deduction Challenges in High-Tax States

High-tax states like New York or California are where this TCJA tax law has had the most significant impact. Let’s say you owe $10,000 or more in property tax. That tax by itself will use up your entire $10,000 capped deduction. You will get no federal deduction for the substantial state income taxes you are likely paying.

Which Pass-Through Entities Qualify for PTE Elections?

Owners of pass-through entities such as partnerships, multi-member LLCs and S-Corporations may be able to get around the $10,000 SALT cap. This can be done by electing to have your pass-through business pay federal income tax on its profits at the entity level. In fact, a majority of states have enacted pass-through entity taxes (PTE taxes).

In these states, pass-through business owners can elect to have their entity pay the state income tax due on the entity’s business income—taxes the owners would otherwise pay individually. The entity will claim a federal business expense deduction for the state income tax payments. The $10,000 SALT cap does not apply to these taxes imposed at a business-entity level, including income taxes for pass-throughs.

Depending on the state tax laws where the owners live, they can either:

  • Receive a state tax credit for the state tax paid by the entity; or
  • Exclude their distributive share of the pass-through’s taxable income from their income for state personal income tax purposes.

In both instances, the owners benefit from a federal tax deduction for all the state income tax due on their pass-through income—even if the amount is far more than the $10,000 SALT cap limit. The IRS approved PTE taxes in November 2020, thus allowing pass-through business owners to take advantage of this strategy.

Know the Tax Laws

Unfortunately, not all business owners can benefit from the PTE. It is only for business entities that are subject to pass-through taxation. Sole proprietors and single-member LLCS are excluded. PTE taxes are elective in all states except Connecticut, where they are mandatory. The rules will vary from state to state, so understand your state’s PTE specific tax laws. Your entity must make a PTE election and pay estimated state income taxes by specific deadlines.

To learn more about PTE tax laws and plan for the $10,000 SALT cap rules, talk with your tax planner and/or financial advisor. Contact Illumination Wealth today to schedule a no-obligation business and personal tax consultation.