Definition
A pass-through entity tax (PTET) is a tax that many states let a partnership or S corporation elect to pay at the entity level on income otherwise taxed to its owners. Owners usually get a credit or exclusion for their share. IRS Notice 2020-75 states that Treasury and the IRS intend to issue regulations confirming that the entity may deduct these payments in computing non-separately stated income for the year of payment. That deduction is why the election works around the federal limit on individual state and local tax deductions.
Why it matters in an audit or review
The same payment can be reported two ways. As the entity's own income tax, it is an expense. As a distribution on behalf of owners, it reduces equity and leaves net income unchanged. Auditors check the policy, consistency, the election, and payment timing.
Example
Illustrative: an S corporation with $1,000,000 of income in a state with a hypothetical 5% elective rate pays $50,000 and deducts it. Owners' federal income falls to $950,000. At an assumed 37% bracket, the saving is $50,000 x 37% = $18,500, if owners could not otherwise deduct the state tax.
Common mistakes
- Deducting a payment in the wrong year. Timing follows the year of payment.
- Switching treatment without a documented basis.
- Missing a state's election deadline.
FAQ
Is a PTET payment deductible by the entity?
Under Notice 2020-75, yes, in the year paid, for qualifying payments by a partnership or S corporation.
Sources
- IRS, Notice 2020-75 (November 9, 2020): https://www.irs.gov/pub/irs-drop/n-20-75.pdf
- FASB ASC 740-10, Income Taxes, Overall
- State statutes for each state's election terms
Definitions paraphrase AICPA and FASB guidance; read the standard itself before relying on a requirement. Example figures are illustrative. This page is guidance, not professional advice. Report an error