Can You Use the SALT Cap Workaround as an S-Corp?

Introduction

S corporation owners in high-tax states like California and New York often struggle with the federal limitation on state and local tax (SALT) deductions, which can substantially increase their effective tax rate and reduce cash flow. Despite the One Big Beautiful Bill Act (OBBBA) raising the SALT cap to $40,000 for 2025 under IRC § 164(b)(6), many S-Corp shareholders exceed this threshold, resulting in disallowed deductions when relying on generic tax advice. Are you harnessing the pass-through entity (PTE) tax election to bypass this cap and deduct state taxes at the entity level? At Kewal Krishan & Co, our expert tax advisors help S-Corp owners save an average of $50,000 annually, potentially totaling $1 million over a decade through targeted SALT strategies. This blog explores whether S-Corps can utilize the SALT cap workaround via PTE elections in 2025, backed by IRC provisions, with detailed examples and compliance steps focused on CA and NY. As OBBBA preserves the cap while states expand PTE options, this strategy remains vital for minimizing federal tax exposure. Implement this workaround effectively with guidance from Our Tax Planning Services.

Understanding the SALT Cap and PTE Workaround for S-Corps

The SALT deduction cap under IRC § 164(b)(6) limits individual deductions for state and local taxes to $40,000 ($20,000 for married filing separately) in 2025, phasing out for modified adjusted gross income over $500,000. For S-Corps, a pass-through entity under IRC § 1366, income flows to shareholders, making personal SALT limits applicable unless mitigated.

The PTE tax election allows S-Corps to pay state taxes at the entity level, deductible as a business expense on the federal return under IRC § 162, bypassing the individual cap. Shareholders receive a state tax credit, often refundable or transferable.

In California, S-Corps qualify for the PTE elective tax at 9.3% on qualified net income per Revenue and Taxation Code § 19900, extended through 2026 by SB 132. Federal deductibility is confirmed by IRS Notice 2020-75.

In New York, S-Corps can elect PTET under Tax Law § 861 at rates up to 10.9%, with NYC offering a similar election under Administrative Code § 11-2401.

Relevant forms include Form FTB 3893 (CA election/payment), Form IT-653 (NY credit), and federal Form 1120-S for deductions.

For detailed rules, see IRS Publication 535.

Eligibility for S-Corps

• State-Specific: Most states (including CA, NY) allow S-Corps to elect PTE tax if all shareholders consent.
• Federal Recognition: IRS treats PTE payments as deductible business expenses (IRC § 162).
• Limitations: Non-resident shareholders may have prorated credits; some states exclude publicly traded S-Corps.

Detailed Example: SALT Workaround Savings for S-Corps

Consider an S-Corp in California with two shareholders, generating $600,000 in qualified net income in 2025. Without PTE, each shareholder reports $300,000 passthrough income, paying $30,000 state tax personally, but capped at $20,000 SALT deduction federally ($10,000 disallowed per shareholder). At a 37% federal bracket, this adds $7,400 in federal tax ($3,700 per shareholder).

With PTE election: S-Corp pays $55,800 (9.3% of $600,000), deducted federally on Form 1120-S under IRC § 162, reducing passthrough income to $544,200 ($272,100 each). Shareholders claim $27,900 state credit each, offsetting personal state tax. Federal savings: $20,646 (37% of $55,800), fully bypassing the cap.

In New York, for $500,000 income at 10.9% PTET ($54,500 payment): Deductible federally, saving ~$20,165 at 37%, with credits applied.

Alternative Scenario

If one shareholder is non-resident, CA prorates credit based on apportionment, potentially reducing benefits but still allowing entity deduction.

Step-by-Step Guide for Taxpayer Compliance

To elect PTE tax as an S-Corp and comply with federal and state requirements, follow these steps:

1. Confirm Eligibility: Ensure S-Corp status under IRC § 1361 and state PTE allowance; obtain unanimous shareholder consent.
2. Make Election: For CA, elect on original Form 100S; for NY, opt-in online by March 15, 2025.
3. Calculate Tax: Determine qualified net income, apply state rate (e.g., 9.3% CA), and make payments (CA: minimum $1,000 by June 15, 2025, via Form FTB 3893).
4. Deduct Federally: Report PTE payment as expense on Form 1120-S, Schedule K, reducing K-1 income (IRC § 162).
5. Claim State Credits: Shareholders report credits on personal returns (CA Form 540 with Form 3804; NY Form IT-201 with IT-653).
6. File Returns: Submit federal Form 1120-S by March 15, 2026, or extend with Form 7004; state returns accordingly.
7. Pay Balances: Remit remaining PTE tax with entity return; monitor for refundable credits.
8. Retain Records: Keep consents, calculations, and payments for three years (IRC § 6001).

For multi-state S-Corps, consider Our Cross-Border Tax Services.

Common Pitfalls to Avoid

• Incomplete Consent: Lack of full shareholder approval voids election; document properly.
• Timing Errors: Miss CA payment deadlines or NY March 15 election, forfeiting workaround.
• Misallocation: Incorrectly prorate for non-residents, reducing credits; follow state apportionment rules.
• Federal Misreporting: Deduct PTE as state tax instead of business expense, triggering disallowance (IRC § 164).

Why Work with a Tax Expert?

Implementing the PTE workaround for S-Corps requires navigating state variances and IRC interactions, where errors can nullify savings or invite audits. Generic preparers may overlook consent requirements or OBBBA cap adjustments, costing thousands. Kewal Krishan & Co specializes in entity-level strategies under IRC § 162, ensuring seamless elections and maximum deductions. Our tailored approach protects against pitfalls, as evidenced in Our Tax Litigation Services.

Conclusion

S-Corps can indeed utilize the SALT cap workaround through PTE elections in 2025, deducting state taxes federally under IRC § 162 while securing shareholder credits, despite the $40,000 cap. OBBBA’s cap increase doesn’t diminish this strategy’s value for high-income owners. With careful election and reporting, significant savings await—assess your S-Corp’s eligibility now to enhance tax efficiency.

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 activate 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. Can S-Corps elect PTE tax?

Yes, in states like CA and NY, allowing federal business expense deduction (IRC § 162).

2. What’s the 2025 SALT cap?

$40,000 for joint filers under IRC § 164(b)(6).

3. How does PTE benefit S-Corps?

Entity pays state tax, deductible federally, with shareholder credits.

4. When to elect in NY?

By March 15, 2025, for the tax year.

5. Are credits refundable?

Often yes in CA/NY, but prorated for non-residents.