Evaluating PTET elections in a post-SALT cap world

ARTICLE | October 13, 2024

Authored by RSM US LLP

Executive summary

• The current $10,000 limit on state and local tax (SALT) deductions is set to end Dec. 31, 2025. This means taxpayers could be able to fully deduct state and local taxes on their federal returns as an itemized deduction starting in 2026.
• Pass-through entity tax (PTET) elections, introduced to address the SALT cap, may not be available in certain states after 2025.
• The alternative minimum tax (AMT) and itemized deduction limitations impact on SALT deductibility must be carefully considered and could limit the benefits of the SALT cap going away.

The state and local tax deduction limitation (SALT cap), introduced by the Tax Cuts and Jobs Act of 2017, limited the amount of state and local taxes that individuals could deduct on their federal income tax returns to $10,000. This cap significantly affected taxpayers in high-tax states, often leading to higher federal tax liabilities. Certain states created Pass-through entity tax (PTET) elections to mitigate the federal SALT cap rule, allowing pass-through entities to pay state taxes at the entity level and thus avoid the $10,000 SALT cap.

Without legislative action, the SALT cap provision is set to expire after 2025. Starting in 2026, taxpayers will once again be able to deduct the full amount of their state and local taxes as an itemized deduction. For certain individual taxpayers, the ability to fully deduct state and local taxes could reduce taxable income and potentially lower overall tax liabilities. However, the interaction with the alternative minimum tax (AMT) and itemized deduction limitations must be carefully considered.

After the SALT cap sunsets in 2025, many of the state PTET workarounds would continue in effect. Out of the 36 states and New York City that have adopted a PTET, approximately 10 jurisdictions conform to the years that the federal SALT cap is in effect or statutorily sunsets at the end of 2025. Only Pennsylvania has a pending PTET proposal, while similar proposals failed in both legislative sessions in Maine and Vermont this year.

Calculating PTET vs. itemized deduction with no SALT cap

Although PTET elections were enacted as a way to avoid the $10,000 SALT cap, they may provide a way to decrease an individual’s tax liability after the cap expires.

• Alternative minimum tax: To the extent that a PTET election is made in most circumstances, this will not be an AMT preference. Taxpayers that would normally fall within the AMT could avoid or mitigate its effects with the PTET election.
• Itemized deduction limitations: The overall 3% itemized deduction limit and the 2% limit on miscellaneous itemized deductions are calculated based upon adjusted gross income, or total income after trade or business deductions but before personal deductions and adjustments. Another effect of the PTET election can be creating an “above the line” deduction for something that is usually an itemized deduction or a reduction of adjusted gross income and the associated limits.

The effects of these elections after Tax Cuts and Jobs Act (TCJA)provisions expire will be complex. Careful modeling and planning will be required to understand if the elections are worth the effort and complexity. However, for many taxpayers it could be a great decision. So, who are those taxpayers?

Who should consider planning for SALT deductions in a post-TCJA world:

If the PTET is available in your resident state or state where you do business, this sort of planning may be right for you if answer yes to any of the following questions:

• Are you a resident of a high tax state?
• Does your pass-through business earn income a high-tax state?
• Do you have significant “low-tax-rate” income, such as qualified dividends or capital gains?
• Is your income more than approximately $300,000 for a married individual or $250,000 for a single individual?
• Do you have significant investment or employment expenditures?

Your tax advisor can help you analyze how your cash tax obligations would be affected by a PTET election after the SALT cap expires.