Do you own a business organized as a pass-through entity (PTE)—such as a partnership, a limited partnership, an S corporation, or a multimember LLC taxed as a partnership or an S corporation? If so, you face an important tax decision.For the past several years, many PTE owners have elected to have their businesses pay the state income tax on their business income rather than paying it personally. This approach allows the PTE to deduct those state income tax payments as a federal business expense.Why Choose This Option?The Tax Cuts and Jobs Act of 2018 capped the personal itemized deduction for state and local taxes (SALT) at $10,000. This cap does not apply to income taxes paid by business entities.As a result, almost all states with income taxes allow PTE owners to elect pass-through entity taxes (PTETs) instead of paying state income tax individually. The IRS has approved this practice, and many PTE owners use it to fully deduct state taxes for federal purposes despite the SALT limitation.
Recent legislation—the One Big Beautiful Bill Act (OBBBA)—did not eliminate or restrict PTETs, which remain optional. However, it did raise the SALT deduction limit to $40,000 for tax years 2025 through 2029. This raises an important question: Should PTE owners skip the PTET election and simply deduct their state income taxes on their personal returns?Not necessarily. PTETs can still offer meaningful benefits, including:
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Overcoming the reduced benefit for high-income taxpayers. The new $40,000 SALT cap phases down once modified adjusted gross income (MAGI) exceeds $500,000. Taxpayers with income above $600,000 receive only a $10,000 deduction.
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Lower federal and self-employment taxes. When your PTE pays state taxes and deducts them as a business expense, it reduces the income passed through to you. This lowers both your federal income tax and your self-employment taxes—12.4 percent Social Security (up to the annual wage base, $176,100 for 2025) and 2.9 percent to 3.8 percent Medicare tax on net self-employment earnings.
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Lower adjusted gross income (AGI) and related advantages. A PTET election lowers your AGI, which may help you (1) avoid the net investment income tax and Medicare surcharge thresholds, (2) qualify for deductions with AGI floors (such as medical expenses and charitable contributions), and (3) preserve deductions and credits that phase out at higher AGIs, including IRA contributions and real-estate loss deductions.
Potential Savings When Using the Enhanced Standard DeductionSome taxpayers will owe less tax by electing PTET and taking the permanently enhanced standard deduction under the OBBBA instead of itemizing.Potential DownsideElecting PTET can reduce your 20 percent qualified business income (QBI) deduction because it lowers the taxable income you receive from the PTE.Bottom LineEvery PTE owner’s situation is unique. You should run the numbers to determine whether a PTET election benefits you.