Pass-Through Entity Tax (PTET): The SALT Workaround, Notice 2020-75 and the Accounting

A state pass-through entity tax (PTET) is an income tax a state imposes on a partnership or S corporation, usually by election, instead of leaving the tax to each owner. The tax exists because of the federal limit on the individual deduction for state and local taxes (the SALT cap). An entity-level tax paid by a partnership or S corporation is deductible in computing the entity's income, so it reduces the income that flows to the owners' Schedules K-1, outside the individual cap.

For auditors and preparers the topic raises two separate questions. The tax question is whether and when the payment is deductible. The accounting question is whether the payment is the entity's income tax expense under ASC 740 or a distribution to owners. The answers differ by state, and getting the second wrong misstates both net income and equity.

This page paraphrases the IRS notice and the accounting literature. Read Notice 2020-75, the relevant state statute and regulations, and ASC 740 for the full text, and have a tax professional apply them to a specific entity.

What does IRS Notice 2020-75 say?

The Treasury Department and the IRS issued Notice 2020-75 on November 9, 2020. It announces that they intend to issue proposed regulations clarifying that state and local income taxes imposed on and paid by a partnership or an S corporation on its income are allowed as a deduction by the partnership or S corporation in computing its non-separately stated taxable income or loss for the taxable year of payment.

Key points from the notice:

• The deduction is at the entity level. The tax is deducted in computing non-separately stated income, so owners do not report a separate itemized state tax deduction for it. The notice relies on the statutory background in sections 164, 702 and 703 and on Revenue Ruling 58-25, which allowed a partnership to deduct a Cincinnati net profits tax it paid.
• The notice cites the legislative history. In enacting the SALT cap in section 164(b)(6), Congress said entity-level taxes on pass-through entities reflected in a partner's or shareholder's distributive or pro rata share on a Schedule K-1 would continue to reduce that share of income.
• The year of payment controls. The deduction applies to the taxable year in which the specified income tax payment is made. Timing of payments, including estimated payments, therefore drives the year of deduction.
• Reliance before regulations. Taxpayers may rely on the notice until proposed regulations are issued. A transition rule also covers payments made in taxable years ending after December 31, 2017 and before November 9, 2020, if made to satisfy a liability under a law enacted before that date.

Does the 2025 SALT cap change matter?

The individual SALT cap in section 164(b)(6) was $10,000 for years beginning after 2017 and before 2026. The One Big Beautiful Bill Act (P.L. 119-21) raised it to $40,000 for 2025, with annual increases of about 1% through 2029 and a phase-down for higher-income households, before reverting in 2030. Law-firm summaries of the final act report that it left the PTET workaround in place.

Whether a higher cap makes PTET less attractive depends on the owner. An owner whose state and local taxes already exceed the cap, or whose income is high enough to lose the benefit of the higher cap, still gains from an entity-level deduction. Modeling is owner-specific.

How do entities account for PTET?

Under ASC 740, taxes based on income are income taxes. The analysis starts with scope. Is the PTET imposed on the entity and based on its taxable income, or is it paid on behalf of the owners? Accounting firm guidance lists the factors:

• whether the tax base is the entity's income or loss, or the owners' attributes
• whether the owners are jointly and severally liable for the tax
• whether the law treats the entity as paying on behalf of its owners
• whether owners may claim the entity's payment on their own returns

If the regime is in scope and attributable to the entity, the payment is income tax expense and the usual ASC 740 current and deferred tax guidance applies. If it is attributable to the owners, the payment is an equity transaction, a distribution. Many state regimes do not fit neatly in either category and the conclusion has to be made state by state, because state laws do not conform. A parent that owns an interest in a pass-through subsidiary generally recognizes income tax only on its controlling interest in the pass-through's pretax income, since the pass-through's taxes are attributable to its owners.

An illustration

Illustrative numbers only, using a hypothetical state PTET rate. An S corporation has $1,000,000 of income sourced to a state with a 5% elective PTET. It pays $50,000 during the year and deducts it in computing non-separately stated income.

The saving is $50,000 x 37% = $18,500, assuming owners had no other way to deduct the state tax because of the cap. In the books, if the payment is treated as an income tax of the entity, expense is $50,000 and net income falls by $50,000. If it is treated as an owner distribution, net income is unchanged and equity decreases by $50,000. The same cash payment produces different financial statements.

What do auditors look at?

Practice observations built from the issues above, not requirements of the notice:

• A state-by-state scope memo. The classification between ASC 740 income tax and owner distribution is the key judgment and should be written down per state.
• Election and payment evidence. Was the election made on time, and were payments made in the year the entity deducted them? Deadlines are set by each state, and a missed election can forfeit the deduction for the year.
• K-1 consistency. Owners' K-1s should reflect the entity-level deduction, and owner-level credits or deductions should match the state's design.
• Presentation. Income tax expense versus distribution in the equity statement must match the memo. See ASC 740 for private companies.
• Tax-basis statements. Entities reporting on a tax basis deduct the payment as paid. See income tax basis of accounting and the tax-basis financial statements template.
• Noncontrolling interests. Where the pass-through is consolidated, tax expense is attributed only to the parent's controlling interest.

Frequently asked questions

Is PTET deductible federally?

Under Notice 2020-75, specified income tax payments by a partnership or S corporation are deductible by the entity in computing non-separately stated income or loss for the taxable year of payment. The Treasury and the IRS announced an intention to propose regulations to that effect.

Did the SALT cap increase eliminate PTET?

No. Commentary on the final 2025 act reports that the PTET workaround was preserved. Whether it still saves tax for a given owner depends on the owner's SALT position.

Is PTET always income tax expense under ASC 740?

No. The classification depends on the state regime and on factors such as the tax base, joint and several liability and whether the entity pays on behalf of its owners. Some regimes are treated as owner distributions.

Which year gets the deduction?

The taxable year in which the payment is made, under Notice 2020-75. Estimated payments made late in one year for a liability of another year can shift the deduction between years.

Sources

• IRS, Notice 2020-75 (November 9, 2020), Forthcoming Regulations Regarding the Deductibility of Payments by Partnerships and S Corporations for Certain State and Local Income Taxes: irs.gov
• IRC sections 164, 702, 703 and 1363; Revenue Ruling 58-25
• Public Law 119-21 (SALT cap provisions); Cooley, "Federal tax legislation extends and increases SALT cap, preserves PTET workarounds" (July 2025)
• The Tax Adviser, "PTETs: Orchestrating ASC 740 compliance" (March 2024); PwC and CLA guidance on state pass-through entity taxes and U.S. GAAP

Related

• ASC 740 income taxes for private companies
• Schedule K-1
• Business tax returns 1065, 1120 and 1120-S
• Book-tax differences
• Income tax provision workbook
• Uncertain tax positions under ASC 740-10

AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error