PTET Election: Why $25,000 of State Tax Saves $7,000, Not $8,750

The 2025 tax law, P.L. 119-21, raised the cap on deducting state and local taxes from $10,000 to $40,400 for 2026, and it is easy to read that as the end of the workaround. For a business owner with more than $505,000 of income, it is the opposite. The higher cap shrinks as income rises, and at about $606,000 it is back to $10,000.

A pass-through entity tax (PTET) election moves the state income tax on business profit from the owner's return to the partnership or S corporation. The entity deducts it in full, outside the cap. In the example below, $25,000 of state tax paid that way cuts the owner's 2026 federal tax by $7,000, less than the 35% bracket suggests, because the deduction also lowers the 20% qualified business income deduction.

For some owners the election saves nothing at all.

1. What the cap allows in 2026

Under section 164(b)(7) of the Internal Revenue Code, as amended by P.L. 119-21, an individual's deduction for state and local income, sales and property taxes is limited to $40,400 for tax years beginning in 2026. The limit rises 1% a year through 2029 and drops back to $10,000 for tax years beginning after 2029. Married couples filing separately get half. Property tax paid on a rental or other business property is outside the cap, because it is deducted against that income.

The limit is reduced by 30% of modified adjusted gross income above $505,000, the same threshold for single filers and joint filers. It never goes below $10,000. Modified AGI here is ordinary AGI plus any foreign earned income or possession income you excluded, so for most owners it is just AGI. At $560,000 the cap is $23,900. At about $606,333 it reaches the $10,000 floor and stays there.

2. Why tax paid by the entity escapes the cap

The cap applies to taxes an individual deducts. It does not reach a tax imposed on and paid by a partnership or S corporation. In Notice 2020-75, the IRS said an income tax a state imposes on the entity, which the notice calls a Specified Income Tax Payment, is deductible by the entity against its ordinary business income for the year it is paid. It counts even when the tax exists only because the entity elected it, and even when the owners get a state credit for it.

The deduction never shows up on the owner's Schedule A. It is already inside the ordinary income on the K-1, and the notice says it is not taken into account in applying the cap to any partner or shareholder. The notice promised proposed regulations and said taxpayers may rely on it until they are issued.

3. What P.L. 119-21 did and did not change

The 2025 tax law leaves the PTET deduction alone. Section 70120 of P.L. 119-21 does two things: it removes the 2025 end date from the cap in section 164(b)(6), and it adds the dollar amounts and the income phase-down in section 164(b)(7). It does not amend the partnership or S corporation rules the notice relies on, and nothing in it addresses taxes paid by an entity.

So for 2026 the position is the same as it was under the old $10,000 cap. The only change is that the cap is now permanent, so the workaround no longer has a 2025 end date to plan around.

4. One couple, both returns

A married couple filing jointly owns all of an S corporation that is not a specified service business. The company pays them $200,000 of salary between them and has $500,000 of profit after that salary. They pay $12,000 of property tax and $30,000 of mortgage interest on their home. Their state taxes individuals and electing entities at a flat 5%, taxes owners on their share before the entity's tax comes out, and gives them a full credit for tax the entity pays, so their state bill is $35,000 either way. Federal income tax for 2026 only, using the brackets in Rev. Proc. 2025-32.

Federal tax falls by $7,000. Without the election, $37,000 of the couple's $47,000 in state and local tax buys no federal deduction. With it, $25,000 of that tax is deducted by the company before the K-1 is issued. Payroll taxes on the salary are the same in both versions.

Both taxable incomes sit in the 35% bracket, which runs from $512,450 to $768,700 for joint filers in 2026. The company's salary also clears the wage limit on the QBI deduction (50% of $200,000 is $100,000), so the deduction is a straight 20% in both versions.

5. Why $8,750 turns into $7,000

A $25,000 deduction at 35% should be worth $8,750. It is worth $7,000 because qualified business income under section 199A(c) is the net of the business's items of income and deduction, and the entity-level tax is one of those deductions. K-1 income falls by $25,000, so the 20% deduction falls by $5,000, and the couple pays 35% on that $5,000.

We treat the payment as reducing qualified business income, the reading that follows the statute's definition. Because the 20% figure is the binding limit in this example, each dollar of entity-level tax removes 80 cents of taxable income, not a full dollar.

The payment also lowers AGI, which matters in the phase-down range. A couple at $560,000 of modified AGI has a $23,900 cap. A $25,000 entity payment brings them to $535,000 and lifts the cap to $31,400, which leaves more room for their own property tax.

6. California and New York run on different calendars

Each state that offers the election sets its own rate, its own owner rules and its own dates. California and New York show how far apart they can be.

California

The Franchise Tax Board allows the election for tax years beginning before January 1, 2031. The tax is 9.3% of qualified net income, which counts only the shares of owners who consent. The election is made each year on a timely filed original return, never on an amended one, and it binds every owner for that year. A first payment of the greater of $1,000 or half the prior year's elective tax is due June 15, and the rest by the return's original due date. For 2026 through 2030, missing the June 15 payment no longer kills the election. Owners instead reduce their credit by 12.5% of their share of the unpaid amount. The owner credit is nonrefundable, and unused credit carries over for up to five years.

New York

The New York Department of Taxation and Finance requires an annual opt-in online between January 1 and March 15 of the tax year itself, made by an authorized person for the entity. Tax professionals cannot make it for clients. The 2026 window closed on Monday, March 16, 2026, because March 15 fell on a Sunday. For 2027 the deadline is Monday, March 15, 2027. The election can be revoked until the first estimated payment is due, and estimates are due on the 15th of March, June, September and December. On the first $2 million of taxable income the PTET rate is 6.85%. An owner whose PTET credit exceeds their New York tax gets the excess credited or refunded.

On the federal side, Notice 2020-75 gives the deduction in the year the entity pays. A cash-method business that pays its 2026 state tax with the return in 2027 takes the deduction in 2027. That includes California's second payment, which is due with the 2026 return.

7. When the election does not help

• There is no state income tax to move. The Texas Constitution bars a tax on the net incomes of individuals, including a partner's share. A Texas owner of a Texas business has nothing to elect.
• You itemize and are already under the cap. If your whole state tax bill is deductible on Schedule A, moving it to the entity turns a full deduction into one that also shrinks your QBI deduction. On $25,000 of tax in the 24% bracket, that costs about $1,200 if you still itemize afterward. If you take the standard deduction instead, the entity deduction is new and the election can still pay.
• The owners live in different states. The election is made state by state for the whole entity. In California it binds owners who did not consent, though their income stays out of the tax base. A nonresident owner claims the credit on a return filed in the electing state.
• Your home state will not give a resident credit. If your home state credits only income tax you paid yourself, and not a tax the entity paid to another state, you can end up paying both states on the same income.
• The business loses money. New York does not let an entity move PTET estimates to its owners. A business that overpays files the PTET return and waits for the refund.

8. Moves to make while 2026 is still open

• Find your 2026 cap. Estimate modified AGI. Above about $606,333, plan on $10,000.
• Run the return both ways. Include the smaller QBI deduction and the change in AGI, not the bracket rate alone.
• Pay in the year you want the deduction. For a 2026 deduction, the entity's payment goes out by December 31, 2026.
• Check each owner's home state. Confirm the resident credit before electing, not after the K-1s go out.
• Put the 2027 dates on the calendar. March 15 for New York, June 15 for California's first payment.

When we take on tax planning for a partnership or S corporation, the first thing we build is that two-column comparison: the return with the election and without it, state credits included. We prepare the entity's state filings and the owners' returns so the payment, the K-1 and the credit agree. Book a call with your 2025 K-1, your year-to-date profit and a list of the states where each owner lives. There are nine weeks left in 2026 to make a payment that counts this year.

General information for owner-operators, not tax advice. Thresholds change and state treatment varies; confirm current requirements for your own facts before acting.