More SALT Please!
I come from a family of salt lovers. We’re always looking for the saltshaker once dinner is served.
Cap our salt intake at your own peril.
Small business owners know limits on salt all too well.
State and local tax (SALT) deductions have been capped at $10,000 since the passing of the Tax Cuts and Jobs Act in 2017.
There are a whole bunch of tax and estate plan laws that will sunset at the end of 2025. There is plenty of speculation as to what may or may not happen.
Regardless of what is enacted later this year and effective on January 1st 2026, the SALT deduction limit is a real pain for those with large state tax liabilities.
The good news? Many states have provided a workaround to the $10,000 deduction limit for business owners set up as pass-through entities.
What is the Pass-through Entity Tax?
The Pass-Through Entity Tax (PTE or PTET) allows business owners to pay income tax at the entity level, where there is no $10,000 state and local tax deduction limit, rather than the usual flow-through of income and expenses to the business owner’s individual tax return, which does have the $10k deduction cap.
Why use PTET for your business?
Unlike the $10,000 SALT deduction cap for individuals, businesses can deduct state taxes as an ordinary business expense on their federal tax turns without limit.
A business owner can then receive a state tax credit for the amount of PTE taxes paid at the entity level which offsets their personal state tax liability.
PTET is a federally recognized workaround so don’t worry about any potential IRS pushback.
IMPORTANT: Pass-through Entity Tax rules vary among states that offer it. Factors, such as eligibility, election method & frequency (annual or one-time), how and when to pay, required forms, allowance of state credit for entity tax paid to another state, interaction with other state tax rules, etc.
Consult with your tax advisor on what rules pertain to your business and if/how you can benefit from electing into PTET.
For this post, I will be referring to California’s PTE tax rules.
Entity Structure
Your business entity must be set up as a partnership or an S Corporation. If there are multiple owners of the business, they all must agree to include their share of income in the PTE tax election.
The PTE tax election MUST be made annually and once elected, you cannot revoke it for that year.
In California, the tax rate for net income at the entity level is a flat 9.3%.
Key Dates
June 15th
The first payment must be submitted by June 15th of the tax year in question. Miss this deadline? You lose PTET eligibility for that year.
The June 15th payment must be the greater of:
$1,000, or
50% of the prior year's PTE tax liability (if any)
Californians, you can pay using FTB Web Pay (online payment system) or using Form 3893 (Pass-Through Entity Elective Tax Payment Voucher)
March 15th
March 15th, the due date for S-Corps, Partnerships and LLC’s taxed as an S-Corp or Partnership, is important for two reasons:
It’s the date in which a taxpayer makes the PTE election and
The deadline for the second and final payment covering the remaining balance for PTE taxes
How to File
While I would strongly recommend working with a certified tax professional on electing and scheduling your PTE estimated payments, here’s how you can file:
For S-Corps, elect PTE on CA Form 100S by March 15th in the year following the PTE election year (i.e. for tax year 2024, that would be March 15th, 2025).
For Partnerships, elect PTE on CA Form 565.
IMPORTANT: While the election takes place on March 15th of the following year, the first estimated payment MUST be made by June 15th of 2024 (for tax year 2024).
The Power of PTET in Action
Without PTET
Jane owns an interior design business structured as an S Corporation in California (For simplicity’s sake, I will ignore the impact of QBI for this example.).
Her California state tax liability is $40,000. Due to the SALT cap ($10,000 limit), she can only deduct $10,000 of this on her federal tax return. The remaining $30,000 is non-deductible, increasing her taxable income and federal tax liability.
If Jane’s federal marginal tax rate is 37%, she would pay $11,100 on that non-deductible state income tax payment.
Jane, cursing the heavens, begs for mercy from the Tax Gods.
As fate would have it, the Tax Gods have answered her plea.
With PTET
Instead of Jane paying her state taxes personally, her S corporation elects to pay the $40,000 tax directly at the entity level.
The S corporation fully deducts the $40,000 as a business expense on its federal return.
Jane receives a California tax credit for her share of the PTE tax eliminating her personal state tax burden.
By deducting the full $40,000 at the entity level, Jane lowers her federal tax bill by $11,100 ($30,000 more in deductions multiplied by Jane’s 37% marginal tax rate = $11,100).
This workaround effectively restores the full SALT deduction for pass-through entity owners.
If Jane’s PTE tax liability is greater than her California state income tax, she is allow to carry forward her unused credits for up to five years.
PTET carryforward rules vary by state. Some don’t allow it and for those that do, the duration of allowable carryforward rules ranges from 3 to 10 years so consult with your tax professional on your state’s rules.
The PTE Tax is a powerful example of proper tax planning throughout the year can potentially save you thousands or tens of thousands in tax savings.
However, PTE may impact other factors like the Qualified Business Income (QBI) deduction or your Alternative Minimum Tax (AMT) so consult with your tax professional or financial planner. And if you do not work with a planner, you know where to find me.
Deduction limits be damned. Use PTE for a SALT deduction limit workaround and reap the sweet reward of a lower tax bill.
Two Palms Planning LLC, doing business as Two Palms Financial, is a registered investment adviser registered with the State of California. Registration does not imply a certain level of skill or training. The content of this publication is for informational or educational purposes only. This content is not intended as individualized investment advice, or as tax, accounting, or legal advice. The information contained herein is based on current tax laws and regulations, which are subject to change. Although we gather information from sources that we deem to be reliable, we cannot guarantee the accuracy, timeliness, or completeness of any information prepared by any unaffiliated third-party. This information should not be relied upon as the sole factor in an investment-making decision. Readers are encouraged to consult with professional financial, accounting, tax, or legal advisers to address their specific needs and circumstances.
