The pass-through entity (PTE) tax strategy is a work around to the limitation on the State and Local tax (SALT) deduction created by the Tax Cuts and Jobs Act (TCJA). Prior to the TCJA, individuals could deduct, subject to alternative minimum tax and overall itemized deduction limits, state and local taxes on their personal returns. However, beginning with the 2018 tax year, the TCJA limited the SALT deduction to $10,000.
Many taxpayers across the country, especially in high tax states, were outraged and looking for some form of relief. Since that time, the PTE strategy has been implemented by many states to provide that relief.
In general, a qualified PTE entity – an entity taxed as an S corporation, partnership, or an LLC taxed as either of the two – can make an election to pay a PTE tax on behalf of the owner’s/partner’s share of their qualified net income from the entity.
If the election is made and the PTE tax is paid, this will generate a tax deduction on the entity’s federal return, which in turn reduces the taxable income reported on the owners/partners federal K1. Hence, providing a deduction for the state taxes related to that income that otherwise would be limited to $10,000, if paid by the individual and deducted on their personal return.
Additionally, the PTE paid will generate a tax credit to partners that elect to participate in the PTE election and can be used to reduce their personal state income tax. It’s important to check if your state has any limitations on utilizing these PTE credits.
In general, electing owners can include estates, trusts, and certain single member LLC’s along with qualifying individuals. However, once again, each state may have a different definition of who are qualified owners that can participate in the PTE election.
Use of the PTE strategy is important to individuals and companies that are structured as a flow-through entity to maximize the SALT deduction and, in turn, reduce federal flow-through income, which might otherwise be limited or denied pursuant to the SALT cap rules.
This has been prepared for information purposes and general guidance only and does not constitute legal or professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its partners, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.
