Introduction
Small business owners in high-tax states like California and New York often grapple with the federal limitation on state and local tax (SALT) deductions, which can inflate their overall tax burden and constrain cash flow. Despite the One Big Beautiful Bill Act increasing the SALT cap to $40,000 for the 2025 tax year under IRC § 164(b)(6), many owners still exceed this threshold, leading to substantial disallowed deductions when relying on inexperienced tax preparers. Are you fully utilizing strategies to circumvent this cap and reclaim your deductions?
At Kewal Krishan & Co, our expert tax advisors help small business owners save an average of $50,000 annually, potentially accumulating to $1 million over a decade through optimized SALT workarounds. This blog outlines the pass-through entity (PTE) tax election—a critical workaround for 2025—with precise IRC references, examples, and compliance steps tailored for CA and NY businesses. By electing PTE tax, you can deduct state taxes at the entity level without the federal cap, securing significant savings. Begin implementing this must-do strategy today with support from Our Tax Planning Services.
Understanding the SALT Cap and PTE Workaround
The SALT deduction cap, enacted under the Tax Cuts and Jobs Act and modified by the One Big Beautiful Bill Act, limits individual deductions for state and local taxes to $40,000 in 2025 (IRC § 164(b)(6)). This restriction phases out for modified adjusted gross income over $500,000. For pass-through entities (PTEs) like LLCs, S corporations, and partnerships, the PTE tax election provides a workaround by shifting state tax payments to the entity level.
In California, the PTE elective tax under Revenue and Taxation Code § 19900 allows qualified entities to pay 9.3% on qualified net income, deductible federally as a business expense under IRC § 162, bypassing the individual SALT cap. Owners receive a non-refundable credit against their state tax. This applies for taxable years 2021-2025, extended to 2026 by SB 132.
In New York, the PTET under Tax Law Article 24-A imposes a tiered rate up to 10.9% on pass-through business income, also federally deductible (IRC § 162). Owners get a credit, with elections due by March 15, 2025. NYC offers a similar PTET under Administrative Code § 11-2401.
Relevant forms include Form FTB 3893 (CA election/payment), Form IT-653 (NY credit), and entity returns like Form 568 (CA LLCs) or Form CT-3-S (NY S-Corps).
For guidance, consult IRS Publication 535 and state resources.
Detailed Example: Applying the PTE Workaround
Consider a California S corporation owned by two partners, with $500,000 in qualified net income for 2025. Without the PTE election, each owner claims SALT deductions on Schedule A, limited to $20,000 each ($40,000 married filing jointly cap). Assuming $30,000 state tax per owner ($60,000 total), $20,000 is disallowed federally, increasing federal taxable income by $20,000 total (assuming 37% bracket, added tax ~$7,400).
With PTE election: The entity pays $46,500 (9.3% of $500,000), deducted federally on Form 1120-S under IRC § 162, reducing passthrough income to $453,500. Owners receive $23,250 state credit each, offsetting personal state tax. Net federal savings: ~$17,205 (37% of $46,500), far exceeding the prior cap limitation.
For a New York partnership with $400,000 income: PTE tax at 10.9% ($43,600) deducted federally, owners credited, saving ~$16,132 at 37% bracket versus capped individual deductions.
Step-by-Step Guide for Taxpayer Compliance
To elect PTE tax and comply with federal and state rules, follow these steps for CA and NY businesses:
- Verify Eligibility: Confirm your entity qualifies (e.g., S-Corp, partnership) and has consenting owners per state laws.
- Make Initial Payment (CA): Pay at least $1,000 or 50% of prior year PTE tax by June 15, 2025, using Form FTB 3893.
- Elect Annually: For CA, elect on original return (Form 565/568); for NY, opt-in online by March 15, 2025.
- Calculate and Pay Tax: Compute PTE tax on qualified income; pay balance by entity return due date (e.g., March 15, 2026, for calendar year).
- Report Federally: Deduct PTE payment on entity federal return (Form 1120-S/1065) under IRC § 162.
- Claim State Credit: Owners report credit on personal returns (CA Form 540, NY Form IT-201) using Form 3804 (CA) or IT-653 (NY).
- File Returns: Submit entity and personal returns by deadlines, extending if needed with Form 7004 (federal) or state equivalents.
- Retain Records: Keep election consents, payments, and calculations for three years per IRC § 6001.
For cross-border implications, explore Our Tax Planning Services
Common Pitfalls to Avoid
- Missing Election Deadlines: CA requires timely payments; NY elections due March 15—late filings invalidate (state statutes).
- Non-Qualifying Income: Exclude non-business or non-resident income from PTE base, per state rules.
- Insufficient Consent: All qualified owners must agree; failure voids election.
- Overlooking Phase-Outs: With the $40,000 federal cap phasing out over $500,000 AGI, assess if PTE still benefits high earners.
Why Work with a Tax Expert?
Navigating PTE elections and SALT workarounds demands precision, as errors can trigger state audits or lost credits. Generic preparers may overlook eligibility or miscalculate, forfeiting savings. Kewal Krishan & Co specializes in state-specific strategies, ensuring full compliance with IRC § 164 and maximizing deductions. Our clients achieve optimal results, as evidenced in Our Tax Planning Services
Conclusion
The PTE tax election serves as an essential SALT cap workaround for small businesses in CA and NY in 2025, allowing uncapped federal deductions under IRC § 162 while providing state credits. Despite the increased $40,000 cap, this strategy remains vital for exceeding thresholds. Timely elections and accurate reporting are key to realizing savings—implement this approach to enhance your financial position.
Call to Action
Schedule a consultation with Anshul Goyal, CPA EA FCA, a licensed U.S. CPA and Enrolled Agent, admitted to practice before the IRS, specializing in tax litigation and cross-border tax for U.S. businesses and Indians in the U.S. Contact us at Kewal Krishan & Co to implement your SALT workaround.
About Our CPA
Anshul Goyal, CPA EA FCA, is a licensed U.S. CPA and Enrolled Agent, representing clients in IRS tax litigation and assisting with cross-border tax compliance for U.S. businesses and Indians in the U.S. His expertise ensures tailored strategies that maximize savings and ensure compliance.
Disclaimer
This blog provides general information for educational purposes only and does not constitute tax, legal, or financial advice. Tax laws change frequently, and individual circumstances vary. Consult a qualified tax professional before making decisions. The author and firm disclaim liability for actions taken based on this content.
FAQs
1. What is the SALT cap in 2025?
$40,000 for joint filers under IRC § 164(b)(6), phasing out over $500,000 AGI.
2. How does PTE tax work in CA?
Entities pay 9.3% on qualified income, deductible federally (IRC § 162), with owner credits.
3. What’s NY PTET rate?
Tiered up to 10.9% on pass-through income, elective by March 15, 2025.
4. Is PTE election revocable?
Generally irrevocable for the year; check state rules.
5. Who qualifies for PTE?
Pass-through entities like S-Corps and partnerships with consenting owners.