How Does PTET Change Under The One Big Beautiful Bill Act?
The One Big Beautiful Bill Act (OBBBA), signed into law on July 4, 2025, significantly impacts the Pass-Through Entity Tax (PTET) provisions, particularly in relation to the State and Local Tax (SALT) deduction cap.
Below is a detailed analysis of its effects based on available information:
Key Impacts on PTET
- Preservation of PTET Deduction:
- The final version of the OBBBA does not impose new limitations on the PTET deduction, preserving the ability of pass-through entities (such as partnerships and S corporations) to deduct state and local taxes paid at the entity level on their federal returns. This is a significant win for taxpayers, as it maintains the workaround that allows pass-through entities to bypass the SALT deduction cap for individual owners.
- Unlike earlier House and Senate proposals, which suggested restrictions on PTET deductions (particularly for Specified Service Trades or Businesses, or SSTBs), the final legislation removed these limitations, ensuring that PTET remains fully deductible at the federal level without being subject to the SALT cap.
- Contrast with Earlier Proposals:
- House Version: The initial House bill proposed disallowing PTET deductions for SSTBs (e.g., businesses in health, law, accounting, financial services, or those where the principal asset is the reputation or skill of employees) and entities not eligible for the Section 199A Qualified Business Income (QBI) deduction. This would have limited the PTET workaround for these businesses, requiring their state tax payments to be reported as separately stated items on Schedule K-1, effectively subjecting them to the individual SALT cap.
- Senate Version: An earlier Senate draft proposed limiting PTET deductions to the greater of $40,000 or 50% of the taxpayer’s allocation of PTET, regardless of SSTB status. However, this restriction was removed in the final Senate-passed bill, preserving the full deductibility of PTET payments
- The final bill, passed by both chambers, adopted the Senate’s approach, ensuring no new restrictions on PTET deductions, which was celebrated by groups like the American Institute of CPAs (AICPA) for maintaining parity between pass-through entities and C corporations.
SALT Cap Increase:
- The OBBBA increases the SALT deduction cap for individuals from $10,000 to $40,000 (or $20,000 for married filing separately) starting in 2025, with a 1% annual increase through 2029 (e.g., $40,400 in 2026). The cap reverts to $10,000 in 2030. This increase benefits individual taxpayers but is subject to a phase-out for those with modified adjusted gross income (MAGI) exceeding $500,000 ($505,000 in 2026, increasing by 1% thereafter).
- Importantly, PTET deductions remain outside the SALT cap, meaning pass-through entities can continue to deduct state taxes paid at the entity level without being constrained by the $40,000 individual cap, providing significant tax planning advantages, especially for owners in high-tax states.
- Impact on Tax Planning:
- Stability for Pass-Through Entities: The preservation of the PTET deduction offers cash flow stability for pass-through entities, particularly for private equity, hedge funds, and other asset management firms that rely on PTET to reduce federal taxable income.
- Strategic Considerations: Business owners should confirm 2025 PTET elections and model the long-term impact of the SALT cap phase-out for high earners. Entities in high-tax states should continue leveraging PTET to maximize federal deductions, especially since the SALT cap increase may not fully benefit high-income taxpayers due to the phase-out.
- The AICPA and other professional groups have noted that maintaining PTET deductibility avoids unnecessary complexity and ensures fairness across business structures.
Background on PTET
- PTET regimes, adopted by 36 states following the 2017 Tax Cuts and Jobs Act (TCJA), allow pass-through entities to pay state taxes at the entity level, which are then deductible on federal returns, bypassing the $10,000 SALT cap for individual owners. The IRS endorsed this strategy in Notice 2020-75.
- The OBBBA’s decision to preserve PTET deductions ensures that this workaround remains a viable tax planning tool, particularly for businesses in high-tax jurisdictions like New York, California, and New Jersey.
Practical Implications
- Business Owners: Pass-through entity owners, including those in SSTBs, should continue to utilize PTET elections where available to maximize federal tax deductions. They should consult tax advisors to ensure compliance with state-specific PTET rules and to optimize entity structure in light of the increased SALT cap and QBI deduction permanence (set at 20% in the final bill, not the 23% proposed by the House).
- High-Income Taxpayers: Those with MAGI above $500,000 should model the impact of the SALT cap phase-out and consider PTET as a primary strategy to mitigate federal tax liability.
- Monitoring: While the final bill preserves PTET, future legislative changes could revisit these provisions, so ongoing monitoring is advised.
Conclusion
The OBBBA maintains the full federal deductibility of PTET payments, rejecting earlier proposals to limit deductions for SSTBs or impose caps on PTET benefits. This preservation, combined with an increased SALT cap to $40,000 (with phase-outs for high earners), provides significant tax planning opportunities for pass-through entity owners, particularly in high-tax states.
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The information presented here should not be construed as legal, tax, accounting, or valuation advice. No one should act on such information without appropriate professional advice and after a thorough examination of the particular situation.
