Instead of losing your federal deduction for state income taxes, you can have your business pay them, and deduct every dollar
Case Study Summary
How a California Business Owner Earning $800,000 Could Save $27,500 in Federal Taxes With One Annual Election
By having their S corporation pay their state income tax through the PTET election, they turned $74,400 of non-deductible state tax into a full federal deduction
Background: Why Can’t You Deduct Your State Income Taxes?
If you live in a high-tax state like California, New York, or New Jersey, you pay a lot in state income tax.
For years, you could deduct all of it on your federal return.
Then in 2018 the federal government capped the deduction for state and local taxes (SALT) at $10,000.
The One Big Beautiful Bill raised that cap to $40,400 for 2026. That sounds like good news.
But there’s a catch most high earners miss. The higher cap phases out once your income passes $505,000.
Your 2026 SALT Deduction Cap by Income
| A: Modified Adjusted Gross Income | B: Reduction (30% of Income Over $505,000) | C = $40,400 – B: SALT Deduction Cap |
|---|---|---|
| $505,000 or less | $0 | $40,400 |
| $550,000 | ($13,500) | $26,900 |
| $606,334 or more | ($30,400) | $10,000 |
Once your income is above about $606,000, you’re right back to the $10,000 cap. Your property taxes alone can use that up.
So every dollar of state income tax you pay above that gets no federal deduction at all.
Is there a way around this?
And the answer is the pass-through entity tax (PTET) election.
What Is the PTET Election?
The SALT cap applies to taxes you pay as an individual.
It doesn’t apply to taxes your business pays.
So most high-tax states now let pass-through businesses (S corporations, partnerships, and LLCs taxed as either) choose to pay state income tax at the entity level, on behalf of their owners.
Here’s how it works:
- Your business pays the state income tax on its profits. In California, the rate is 9.3%.
- Your business deducts that tax as a business expense on its federal return. That lowers the profit that flows through to you.
- You get a state tax credit for your share of what the business paid, so you aren’t taxed twice at the state level.
The state tax is the same either way. The difference is that you now get a federal deduction for it.
How Much Does It Save?
Let’s look at a quick example.
Let’s say you own an S corporation in California that earns $800,000 a year. Your income is well above the phase-out, so your SALT cap is $10,000, and your property taxes already use it up.
At California’s 9.3% PTET rate, your business would pay $74,400 in state income tax.
Federal Taxes With and Without the PTET Election
| Approach | A: Pass-Through Income | B: State Tax Deducted on Federal Return | C = A + B: Federal Taxable Income | D: Federal Tax Rate | E = C × D: Federal Tax Owed |
|---|---|---|---|---|---|
| No PTET election | $800,000 | $0 (blocked by SALT cap) | $800,000 | 37% | $296,000 |
| With PTET election | $800,000 | ($74,400) | $725,600 | 37% | $268,472 |
The PTET election saves $27,528 in federal taxes this year, on the same income and the same state taxes.
(For simplicity this uses a flat 37% federal rate on all income. Actual savings depend on your brackets.)
And because the deduction lowers your adjusted gross income, it can help with other limits tied to your income as well.
What’s the Catch?
The PTET election is one of the simplest strategies on this list, but it has rules you have to follow:
- You need a pass-through entity. Sole proprietors and single-member LLCs that aren’t taxed as an S corporation or partnership generally can’t make the election. This is one more reason to review your entity (see “Choosing the Right Business Entity”).
- In California, timing matters. The business has to prepay by June 15 the greater of $1,000 or 50% of the prior year’s PTET. For 2026 through 2030, missing that payment no longer cancels the election, but it does reduce each owner’s credit.
- Don’t overpay. If your income drops, a prepayment based on last year’s higher profits can leave cash sitting with the state. Model the payment before June 15.
- The election is made every year. It isn’t automatic, so it needs to be part of your annual tax planning.
- Every state is different. Rates, deadlines, and credit rules vary. California’s program currently runs through 2030.
Who This Strategy Is Best For
- ✓Owners of S corporations, partnerships, and multi-member LLCs
- ✓Business owners in high-tax states like California, New York, and New Jersey
- ✓Anyone with income above the SALT cap phase-out, around $505,000 and up in 2026
- ✓Professional practice owners whose profits flow through to their personal return
- ✓Anyone impacted by the $10,000 SALT deduction cap
Explore Your Strategy
Speak directly with Rajiv Rebello to see how this strategy fits into your comprehensive tax plan.