Can You Reduce Your Tax Burden with a PTET Election?

If you’re like most business owners, the term “tax saving strategy” makes your ears perk up. You don’t want to pay more than necessary, but navigating the maze of tax laws can be daunting. One newish tax-saving strategy you might have heard about is electing the Pass-Through Entity Tax (PTET). Depending on your state and how your business is structured, the PTET could be an opportunity to reduce your federal income tax burden.

So, let’s dive into what the pass-through entity tax is and why you should discuss it with your accountant if they haven’t brought it up yet.

What is PTET?

The Pass-Through Entity Tax (PTET) is a state-level tax election that allows pass-through entities, including partnerships, S corporations, and limited liability companies (LLCs) that elect to be taxed as S corporations, to pay state income taxes at the entity level rather than passing the tax burden onto individual owners.

Since the Tax Cuts and Jobs Act (TCJA) of 2017 capped the state and local tax (SALT) deduction at $10,000, business owners have been looking for legitimate workarounds to deduct more of their state and local taxes than allowed under their itemized deductions.

Several states created that workaround, creating a state-imposed entity-level tax on pass-through entities. Where available, making a PTET election allows pass-through businesses to pay the state tax owed on business income rather than passing that taxable income through to the owners, members, or shareholders, who lose out on deducting the taxes paid from their personal income tax returns due to the SALT cap.

It sounds complicated, but by electing PTET, businesses essentially convert a non-deductible personal expense into a deductible business expense.

And because it is complicated, let’s say it another way: the PTET election allows your business to pay your personal state income tax and deduct it as a business expense. 

How does PTET work?

Here’s the rub: not all states have a PTET, and they don’t follow any uniform guidelines. Each state has its own provisions, requirements, and limitations.

But the gist is that when a pass-through entity elects PTET, the business pays the state income tax on its earnings. Then, the company can deduct the payment as a business expense on its federal income tax return, just as it would for payroll and property taxes.

The business owners receive the benefit through Schedule K-1, which shows their share of taxable income from the business. States generally fall into one of two groups:

  1. Reduce federal adjusted gross income. Some states, including Colorado, North Carolina, and Wisconsin, allow owners or shareholders to reduce their federal adjusted gross income (AGI) by their share of income from the pass-through entity.
  2. Claim a tax credit. Other states, including California, Illinois, and New York, require owners and shareholders to include their share of pass-through business income on their individual income tax returns. Then, they allow the owners to claim a tax credit for their share of state income taxes paid by the pass-through entity.

Most states require the business to make estimated payments throughout the year in which they want to make a PTET election. You can’t count on paying a year’s worth of estimated tax payments when you file your return.

Which states have a PTET?

Not all states offer a PTET election, but several have adopted this measure since its inception.

The PTET rules can vary from state to state regarding whether the election is binding or the company needs to annually elect the PTET and who is authorized to make a PTET election.

If your business operates in a state that offers PTET, it’s worth investigating whether this election could benefit you.

Why consider PTET?

Because each state takes its own approach to the PTET, it can be tough to determine whether your business qualifies and what you need to do to take advantage of this tax strategy. But that effort might be worth it. Just consider these potential benefits:

  1. Tax savings. The PTET’s primary advantage is avoiding the $10,000 cap on the SALT deduction. If you qualify, you can deduct a larger percentage of your state income taxes paid for federal income tax purposes.
  2. Bypass the Alternative Minimum Tax (AMT). The PTET isn’t subject to the AMT. The AMT was designed to limit tax benefits for high-income taxpayers. Essentially, some taxpayers have to calculate their federal taxable income under regular tax rules and AMT rules and pay the higher of the two. The AMT generally applies to SALT deductions but not to PTET.
  3. Simplified tax filing. For some businesses, PTET may simplify tax filing by consolidating state tax payments at the entity level rather than distributing them to individual owners.

If that sounds good to you, time isn’t on your side. Some states require you to pay installments by a specific deadline to make a PTET election for that year. For example, California requires businesses to make an estimated payment by June 15 as a prerequisite to making the PTET election. Meanwhile, New York requires businesses to make the election by March 15 of the same tax year and doesn’t make any concessions for late filing.

Is PTET right for your business?

While PTET can offer significant tax advantages, it’s not a one-size-fits-all solution.

If you’re located in a state that offers the PTET option, it’s essential to work through the nuances of the state’s provisions, model the tax impact on you and your business, and assess whether the potential benefits outweigh any drawbacks.

For example, it might not make sense if your business has some shareholders who are residents of states that don’t allow them to claim a PTET credit on their state personal income tax returns.

If you haven’t already, now is a good time to chat with your accountant about PTET. After all, who wouldn’t want to turn a tax burden into a tax benefit? If you need help evaluating whether the PTET is right for your business, please reach out. We’re happy to help you stay informed and proactive about your tax planning to ensure you take full advantage of the opportunity.

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