The SALT Cap and the Pass-Through Entity Tax Election

The federal deduction for state and local taxes is capped at $40,400 for 2026 under the One Big Beautiful Bill Act, but that cap phases down for higher earners: the benefit begins shrinking at $500,000 of modified adjusted gross income and is reduced by 30 cents per dollar above roughly $505,000, returning to a $10,000 floor once income reaches roughly $606,000. For owners of pass-through businesses, there is a legitimate and widely used way around this limit. Most states with an income tax now permit a pass-through entity tax, or PTET, election, in which the business pays the state income tax at the entity level and deducts it as an ordinary business expense on the federal return. That deduction is not subject to the individual SALT cap at all, so the state tax becomes fully deductible again. Importantly, OBBBA left the PTET workaround intact; a provision that would have restricted it for service partnerships was removed before the bill passed.

How does the 2026 SALT cap actually work?

The mechanics matter, because the phase-out creates a band of income where the marginal effect is unusually harsh.

For 2026, the cap on deductible state and local taxes is $40,400, up substantially from the $10,000 limit that applied under prior law. But the increased cap is not available to everyone. Once modified adjusted gross income exceeds roughly $500,000, the additional cap amount phases out at 30 cents per dollar of income above the threshold, with the deduction never falling below a $10,000 floor. By the time MAGI reaches roughly $606,000, the taxpayer is back to the $10,000 cap. Both the cap and the threshold step up by a fixed 1% per year rather than by inflation, and the expanded cap is scheduled to run through 2029, reverting to $10,000 in 2030.

The consequence is a phase-out band, roughly $505,000 to $606,000 of MAGI, in which each additional dollar of income both is taxed and destroys 30 cents of deduction, producing an effective marginal rate meaningfully above the stated bracket. That band is worth knowing about, because it makes the timing of income and deductions more consequential than usual, a theme we develop in high-income tax planning for 2026.

What is the pass-through entity tax election?

The PTET is a state-level regime that shifts where the state income tax is paid, and therefore how it is treated federally.

Normally, a partnership or S corporation does not pay state income tax itself. Income flows through to the owners, who pay state tax personally, and that personal state tax payment runs into the federal SALT cap. Under a PTET election, the entity elects to pay the state income tax at the business level instead. The entity then deducts that payment as an ordinary and necessary business expense, which reduces the federal taxable income flowing through to the owners. Because the deduction happens at the entity level, it is not an itemized deduction and is not subject to the individual SALT cap.

The owners typically receive a corresponding state tax credit, or an exclusion of the income, so they are not taxed twice by the state. The net result is that the state tax is economically the same, but it becomes fully deductible for federal purposes.

This treatment rests on IRS Notice 2020-75, in which the IRS confirmed that entity-level state taxes paid by a partnership or S corporation are deductible by the entity and are not subject to the individual SALT limitation. That guidance is what turned a state-level idea into a mainstream planning technique, and the states responded quickly: the large majority of states with an income tax now offer some form of PTET.

Who benefits, and by how much?

The technique applies to owners of pass-through entities, meaning partnerships, S corporations, and LLCs taxed as either, who have meaningful state income tax on business income. It does not help with state tax on wages, and it does not apply to sole proprietorships filing on Schedule C, since there is no entity to make the election. It also provides no benefit in a state without an income tax.

The value scales with the amount of state tax on pass-through income. An owner whose share of state tax on business income is $80,000 and who is otherwise capped may convert a largely non-deductible expense into a fully deductible one, which at a 37% federal rate is worth a substantial sum. For owners in high-tax states with significant pass-through income, this is often the single largest federal tax planning item available to them.

The entity structure question sits underneath all of this, and is covered in the business entity primer. The PTET deduction also flows through on the Schedule K-1, which is discussed in how to read a Schedule K-1.

What are the traps?

Several, and they are mostly procedural, which means they are avoidable with planning and unforgiving without it.

Deadlines and payment timing.Most PTET regimes require the election and, critically, the payment to occur within the tax year to secure the federal deduction, since the entity generally deducts the tax when paid. Several states require estimated payments during the year, and California, for example, requires a prepayment by mid-June to preserve the election. Missing a payment date can forfeit the benefit for the entire year.

Elections are often annual and sometimes irrevocable.The election frequently must be made each year, and in many states it binds all owners once made.

Owner-level consequences vary.Some states give owners a credit; others exclude the income. Owners who live in a different state from where the business operates may find that their home state does not grant a credit for another state's PTET, creating double taxation. This is one of the most common problems in multi-state situations.

Rules are not uniform and they change.Each state's regime differs on rates, deadlines, eligible entities, and owner treatment, and states continue to modify them. Minnesota's PTET, for instance, had been scheduled to expire after 2025, but the legislature re-enacted it in May 2026, retroactive to January 1, 2026, and it now runs through 2027. Anyone relying on a PTET should confirm the current rules in each relevant state annually.

It interacts with other items.The PTET deduction reduces qualified business income, which can reduce the Section 199A deduction, so the net benefit is smaller than the gross deduction suggests. It also affects basis and distributions. This is why the calculation belongs with your CPA rather than a rule of thumb.

A worked example: the value of the election

The following is a hypothetical illustration, simplified and ignoring the Section 199A interaction. An owner of an S corporation has $2,000,000 of pass-through business income and lives in a state with a 7% income tax, producing roughly $140,000 of state tax on that income. Her MAGI is well above $600,000, so her federal SALT deduction is limited to $10,000.

Without a PTET election, she pays the $140,000 personally and deducts only $10,000 of it federally. Roughly $130,000 of real state tax produces no federal benefit.

With a PTET election, the S corporation pays the $140,000 to the state and deducts it as a business expense. The income flowing through to her federal return is reduced by $140,000, and she receives a state credit so she is not taxed twice at the state level. At a 37% federal marginal rate, deducting an additional $130,000 that was previously wasted is worth roughly $48,000 in federal tax. Her actual benefit would be somewhat lower after accounting for the reduction in qualified business income and the resulting Section 199A effect. The figures are hypothetical and the outcome depends on state rules and her full return.

Frequently asked questions

What is the SALT cap for 2026?$40,400, up from $10,000 under prior law, but it phases down at 30 cents per dollar of modified adjusted gross income above roughly $505,000 and returns to a $10,000 floor at roughly $606,000 of MAGI. The cap and threshold each step up 1% per year through 2029.

Did the One Big Beautiful Bill Act eliminate the PTET workaround?No. A provision that would have restricted the pass-through entity tax for certain service partnerships was removed before final passage, so PTET regimes remain available. This was one of the more consequential items for business owners in the final bill.

Who can use a pass-through entity tax election?Owners of partnerships, S corporations, and LLCs taxed as either, in states that offer a PTET regime. It does not apply to sole proprietorships filing on Schedule C, does not help with state tax on wages, and provides no benefit in states without an income tax.

Is the PTET election legal?Yes. The IRS confirmed in Notice 2020-75 that entity-level state income taxes paid by a partnership or S corporation are deductible by the entity and are not subject to the individual SALT limitation. Most income-tax states subsequently enacted PTET regimes.

What is the biggest mistake with a PTET election?Missing the payment or election deadline, which can forfeit the deduction for the entire year. Multi-state owners also need to confirm that their home state credits another state's PTET, since a mismatch can create double taxation.

Does the PTET reduce my qualified business income deduction?Generally yes, at least in part, because the entity-level deduction reduces the income eligible for the Section 199A deduction. The net benefit is therefore smaller than the gross deduction, which is why the analysis should be run rather than assumed.