What Is Pass-Through Entity Tax?

Pass-through entity tax is a relatively new tax planning option that grew out of a major shift in federal tax law. When new limits on state and local tax (sometimes called SALT) deductions went into effect in 2018, the after-tax cost of owning a pass-through business suddenly increased, especially for owners in higher-tax states. In response, many states moved quickly to create PTET as a way to soften that blow.

PTET has since become popular among business owners, CPAs and financial planners because it can potentially reduce overall federal tax exposure without increasing state taxes. If you own a business, understanding how PTET works is key to deciding whether it belongs in your broader tax strategy.

WHAT IS A PASS-THROUGH ENTITY?

A pass-through entity is a business structure in which profits are “passed through” to the business owners and taxes are assessed at the level of an individual owner instead of the business itself.

COMMON TYPES OF PASS-THROUGH ENTITIES

If you own a business, it’s likely to be structured as a pass-through entity – most are. Here are the four types of pass-through entities:

• S corporations
• Partnerships
• Sole proprietorships
• Limited liability companies taxed as partnerships, S corporations, or Schedule C (sole proprietorships)

LLCs are unique in that they can elect to be taxed as a corporation rather than a pass-through entity.

HOW PASS-THROUGH INCOME IS NORMALLY TAXED

For a pass-through entity, the business itself generally doesn’t pay federal income taxes. Instead, profits are passed through to the owner or owners, who then report the income, losses, deductions and credits on their own individual tax returns and pay individual tax rates, not corporate.

HOW PTET WORKS

THE ENTITY-LEVEL TAX ELECTION

Relatively recently, for reasons we’ll get to, many states have created a new PTET option. It allows pass-through business owners to choose to be taxed at the entity level instead of the individual level when it comes to state taxes.

Since PTET is paid by the business, the money for the tax payment is deducted from the profits and therefore not passed through or taxable as individual income at the federal level.

STATE TAX PAYMENT AND OWNER CREDITS

The idea of PTET is to reduce federal taxes, not to increase state taxes. So, in some states, any share of income which was already taxed under PTET is removed from an individual's income for state tax purposes. In other states, it’s still included as income, but business owners also receive a state tax credit to offset it. (The credit isn’t always 100% of the tax paid, however.)

ANNUAL ELECTIONS AND FILING REQUIREMENTS

The timing and requirements for electing PTET vary by state, but in most cases it’s an annual election.

DOES PTET REDUCE FEDERAL INCOME TAX?

THE SALT DEDUCTION LIMITATION

PTET came about because of changes to federal tax law that severely limited the amount of state and local taxes that many individuals (not just business owners) can deduct on their federal taxes. A lower deduction generally means these taxpayers now face higher tax bills.

The group of state and local taxes affected by the limit is commonly referred to as “SALT.” Starting in 2018, a SALT limit of $10,000 was introduced. (And in 2025, the limit was temporarily changed – we'll get to that.)

Many states, wanting to encourage business development and support business owners, created PTET as a workaround.

HOW PTET MAY CHANGE THE DEDUCTION TREATMENT

How does a new tax make overall taxes lower? Well, rather than being part of the SALT deduction, PTET is treated as a business expense and simply deducted from the income before it’s passed through. Any amount of PTET can be removed from income for federal tax purposes – unlike SALT, it’s not limited.

WHY RESULTS VARY BY TAXPAYER

If you elect PTET, your results will vary based on your own situation (how much income you have, what other deductible expenses you have, how your business is structured) as well as your state’s PTET rules, tax rates and procedures. In many cases, electing PTET could save on your total state and federal tax bill, but not always.

WHAT ARE THE ADVANTAGES OF PTET?

POTENTIAL FEDERAL TAX DEDUCTION BENEFITS

As explained, PTET came about as a workaround for business owners who were impacted by the SALT limit. In 2025, a new twist was added, as the SALT limit was temporarily increased to $40,000 for most people (through 2029).

That can change the math on whether electing PTET is beneficial for you. But it could still help even if your deductible taxes are now within the limit.

For example, if your itemized deductions are only a little higher than the standard deduction, you would still typically itemize – every dollar counts, after all. But if you elect PTET, both your income and your deductions will be lower (your income because less is being passed through, and your deductions because you’re paying less in SALT).

Assuming your itemized deductions are now lower than the standard deduction, you’ll probably switch to the standard deduction – but remember that you’ve also removed some of the pass-through income. That income that’s no longer getting taxed plus the standard deduction could be more than the itemized deductions you’d otherwise qualify for. Overall, this could reduce your federal taxes.

With high income earnings, the new $40,000 SALT limitation may phase down to $10,000. By making the PTET election, you may be able to work around the phase-out limitation.

PLANNING OPPORTUNITIES FOR HIGH-INCOME OWNERS

If you’re required to pay self-employment taxes (usually this applies to sole proprietors and partnerships), another way PTET can help is by lowering these (Medicare and Social Security) taxes, because anything you pay in PTET isn’t passed through as income and therefore is not subject to self-employment tax.

ALIGNMENT WITH BROADER TAX PLANNING

Your business – and the PTET decision – is just one aspect of your overall tax situation. And in most states, the decision can change each year as tax laws change and make it more or less beneficial. Multi-year comprehensive planning is necessary in order to take the best advantage of opportunity. This is why we recommend you always work with your tax professional on complex tax situations.

WHAT ARE THE DISADVANTAGES OF PTET?

CASH FLOW AND TIMING CONSIDERATIONS

Some states require businesses electing PTET to pay estimated taxes up-front, which could mean a cash flow crunch for the business. While you should see a tax benefit down the line when you file your annual income tax returns (at least, that’s the idea), the gap in timing needs to be planned for.

ADMINISTRATIVE COMPLEXITY

The recordkeeping, calculations and filings for PTET can get complicated, especially if the business has multiple owners in different states or if not all owners choose to elect PTET.

STATE-SPECIFIC RULES AND UNCERTAINTY

You’ll have to know the specific rules in your state for which businesses can elect PTET and the timing and mechanism for electing it. If you live in a different state than your business is located, you’ll also have to understand how your state treats PTET paid to other states. And if your business has multiple owners, you’ll need to know if you’re allowed to choose differently or if all need to make the same election.

WHO MIGHT CONSIDER A PTET ELECTION?

BUSINESS OWNERS IN HIGH-TAX STATES

A major reason for choosing PTET is the SALT limit. Not everyone hits the limit, but you’re likely to if you live in a state with high income and property taxes (and that likelihood will increase again in 2029 when the limit returns to $10,000).

OWNERS WITH SIGNIFICANT PASS-THROUGH INCOME

If your income is relatively low, and/or if you take the standard deduction rather than itemizing deductions on your federal return (in which case the SALT limit is irrelevant to you), PTET might not offer you much. The higher your income, the more the benefit could be.

THOSE ALREADY ENGAGED IN TAX PLANNING

As we explained, electing PTET isn’t always the right choice. You should make your decision in partnership with a tax professional who can consider your full tax picture when offering guidance.

HOW PTET FITS INTO RETIREMENT AND WEALTH PLANNING

MANAGING ONGOING TAX LIABILITIES

Because many states require up-front PTET payments from the business itself, forward-looking projections are especially important, both to ensure taxes are paid on time and to avoid disrupting business operations or personal savings goals. When PTET is incorporated into a long-term plan, those timing differences can be anticipated and managed rather than becoming surprises.

COORDINATING WITH RETIREMENT INCOME STRATEGIES

PTET may also influence how business owners think about retirement contributions and distributions. Because PTET reduces the amount of income passed through to you, it can affect adjusted gross income, which in turn may impact contribution eligibility, tax bracket management and the taxation of future retirement income.

If you pay self-employment tax, PTET will also reduce it – which is a benefit in the moment, but will also reduce the earnings base on which your Social Security benefits are calculated. And that could lead to smaller checks years from now.

COMMON QUESTIONS ABOUT PTET

IS PTET AVAILABLE IN EVERY STATE?

As of March 2026, 36 states have a PTET and two additional states have proposed bills that would create a PTET. (Some states which have a PTET slated to expire after 2025 have pending legislation to push out the expiration date.) Nine states have no individual income tax (making PTET irrelevant), leaving only three states without a PTET or any plans to create one.

IS PTET MANDATORY?

For states that allow it, PTET is optional and must be elected.

DOES PTET ALWAYS RESULT IN TAX SAVINGS?

Not always. Business owners should consult with a tax professional when deciding whether to elect PTET and should reconsider the election every year.

A POWERFUL TOOL FOR BUSINESS OWNERS

Pass-through entity tax can be a powerful planning tool, but it’s not automatically the right move for every business owner. The potential benefits depend on your income, your state, your business structure and how PTET fits alongside everything else on your balance sheet.

Like most effective tax strategies, PTET works best when it’s evaluated as part of a personalized plan and revisited regularly as laws and circumstances change. With the right analysis and professional guidance, it can play a meaningful role in reducing taxes while keeping your broader financial goals front and center.