Pass-Through Entity Tax (PTET): How Business Owners Can Lower AGI & Save on Taxes

The Tax Cuts and Jobs Act (TCJA) of 2017 brought sweeping changes to the tax code. While most Americans saw their federal taxes drop, the changes were not uniformly positive. Taxpayers in high-tax states faced a significant drawback: a cap on state and local tax (SALT) deductions. For those itemizing their deductions, a hard cap of $10,000 ($5,000 for married taxpayers filing separately) was imposed, leaving many at a disadvantage.

To add insult to injury, while the standard deduction has increased annually with inflation, the SALT cap has remained fixed since 2018. In 2025, married couples filing jointly can take a standard deduction of $30,000. This makes itemizing impractical unless deductions like mortgage interest, charitable donations, and other (much less common deductions) exceed $20,000. As a result, fewer than 10% of taxpayers claimed itemized deductions in 2020, down from over 30% in 2017. Millions of taxpayers were hosed on the East and West coasts.

36 states have adopted a Pass-Through Entity Tax (PTET) to address this. This clever workaround allows business owners and shareholders to deduct SALT expenses at the business level rather than as an itemized deduction on their personal tax returns.

Let’s explore how this works and why it matters.

Advantages of a pass-through entity tax

Compared to taking SALT as an itemized deduction, the PTET deduction through the business has several advantages:

The cap ($10,000 for most filers) is lifted.
Even if you take the standard deduction (which is likely if you don’t have a big mortgage or donate much to charity), you can still deduct some state and local taxes.
Unlike itemized deductions, which are “below the line,” PTET deductions reduce business income, lowering your adjusted gross income (AGI).

For the purposes of this article, we’ll focus primarily on the third benefit, as a lower AGI can unlock substantial savings and other financial advantages.

Who can benefit from the pass-through entity tax (PTET)?

Unfortunately, most taxpayers can’t take advantage of the PTET deduction. You must meet these criteria:

You need to file a separate business return with your state. An S-corporation or partnership would generally fit the bill, but a sole proprietorship would not (since this is included in a taxpayer’s personal return). This is why the availability of the PTET can factor into deciding which business structure to use.
The business would need to have a net profit after accounting for expenses. This means you’d need to have a positive number after taking the revenue and subtracting all expenses, including compensation to an S-corp owner and guaranteed payments to a partner.

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So, how does the PTET work?

It’s important to remember that S-corporations and partnerships don’t generally pay taxes at the business/entity level (at least federally). However, some states, such as California and Tennessee, and cities, such as Washington, D.C., and New York City, impose taxes on S-corporations.

Instead, profits are “passed through” to the owner’s personal return and taxed at their marginal tax rate. The Pass-Through Entity Tax allows the owner or shareholder to opt out of this and pay the taxes owed on this income by calculating it on the state business return instead.

Each state calculates the PTET differently. To determine the amount due, they’d multiply the net income by the PTET rate for their state.

While the income is still passed through to their state personal return, each state has a mechanism to prevent the income from being double taxed:

Some states grant you a credit against your tax liability on the personal return (ideally, this is a refundable credit, but others require you to carry forward any unused credit).
In other states, the income from the business is subtracted from the taxpayer’s total state income.

It’s important to note that the PTET rate varies by state but is usually flat at or around that state's highest marginal tax rate. For this reason, it’s possible (but not always the case) that the PTET will increase the total state taxes compared to how much would have been paid without the PTET election. If this is the case, ensure that the federal tax savings exceed any increases in state taxes.

The value of the PTET results from its ability to be deducted on the federal business return — if the business is profitable, every dollar deducted this way also lowers AGI by the same amount.

Still, the value of the PTET deduction depends heavily on your state’s rules. Consult with a tax advisor familiar with your state's rules to get an accurate estimate of the potential savings.

Real-world example of the PTET

Consider Danielle, a successful business owner in California. Her practice is taxed as an S-corporation and generates $200,000 in annual profit.

Her IRS Form 1040 (personal income tax return) shows an adjusted gross income (AGI) of $400,000, including the $200,000 business profit (documented on a Schedule K-1 tax form).

She paid the state $25,000 during the year through W2 withholdings. In addition, she made an estimated $10,000 payment to the California Franchise Tax Board (FTB). Of the $35,000, she can only deduct $10,000 on her federal return under the SALT cap — but she takes the standard deduction ($15,000) in 2025 because this is more than her itemized deductions.

If she had elected to do the Pass-Through Entity Tax, she would have paid tax on $200,000 worth of income through her state’s business return (and should have made estimated payments for this during the year). The PTET rate is 9.3%, which means the tax liability is $18,600.

The $18,600 paid to the state of California is taken as a deduction on the federal business tax return (IRS Form 1120-S). As a result, the business income on Danielle’s federal tax return decreases from $200,000 to $181,400. (Note that it remains $200,000 on her state return since states generally don’t allow you to deduct their income taxes). Her AGI similarly decreases to $381,400. She is still able to take the standard deduction of $15,000.

Her federal marginal tax rate is 35%, and by deducting $18,600, she saves about $6,500 in federal taxes ($18,600 x 35%). Her state return still calculates her tax liability at $400,000, but she can take a credit of $18,600 paid to the state through her business.

In this example, the total state taxes paid are the same.

Why is it better to take above the line deductions?

In this example, we’ll stipulate that Danielle is a student loan borrower with $500,000 of debt enrolled in the SAVE (Saving on a Valuable Education) plan. Her annual student loan payment is 10% of her AGI, meaning she would save $1,860 through monthly payment reductions ($18,600 x 10%). So, in this example, the value of the PTET is over $8,000. The amount of her standard or itemized deductions has no bearing on her AGI or calculated student loan payments.

What’s more, there are several other possible tax deductions and credits that you can see reduced or lost altogether as AGI increases. These include, but are not limited to, the following:

Child Tax Credit and Credit for Other Dependents
Credit for the purchase of an electric vehicle
Student loan interest deduction
Education credits, such as the American Opportunity Credit and Lifetime Learning Credit
Premium Tax Credit
Adoption Credit
Retirement Contributions Credit

Likewise, some extra taxes, such as the Net Investment Income Tax (NIIT), kick in at a higher AGI, regardless of the standard or itemized deduction amount. Medicare Part B and D premiums are also based on the AGI from two years before.

Is the PTET right for you?

The example described above is deliberately simplified. Needless to say, the impact of reducing AGI depends highly on your individual situation, but this tends to be especially valuable for student loan borrowers who are paying 10% or more of their AGI in student loan payments. There is also no guarantee of how long these benefits will last, as the tax code and federal student loan policy constantly change.

You should not mistake this article or the example included as advice that applies to you. State-specific rules and potential trade-offs mean consulting with a tax advisor is essential. You can determine whether the PTET is a smart strategy for your financial goals by exploring your options.

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