Business tax
PTET: how the pass-through entity tax works around the SALT cap
A pass-through entity tax (PTET) is a state income tax that a partnership or S corporation chooses to pay itself, on its owners’ behalf. The owners get a state tax credit, so their state tax barely changes, but the business deducts the tax on its federal return, where the $40,400 SALT cap for 2026 does not apply. For owners whose state and local taxes run past the cap, that turns a lost deduction into a real one. Illinois’s version is 4.95%, and since December 2025 it no longer has an end date.
Why PTET exists: the SALT cap
Individuals who itemize can deduct state and local income, sales and property taxes only up to a cap. The July 2025 tax law raised it and made it permanent, but with an income limit that pulls it back down for high earners.
| Item | 2025 | 2026 |
|---|---|---|
| SALT cap | $40,000 | $40,400 |
| Cap starts shrinking above modified AGI of | $500,000 | $505,000 |
| How fast it shrinks | 30% of the excess | 30% of the excess |
| Lowest it can go | $10,000 | $10,000 |
| Modified AGI at which it reaches $10,000 (about) | $600,000 | $606,333 |
How PTET gets around it
IRS Notice 2020-75 says that when a partnership or S corporation pays a state income tax imposed on the entity, including one the entity elected to pay, the entity deducts it in figuring its income. The deduction is not passed to the owners as a separate item and does not count against their SALT cap. It simply lowers the profit on their K-1s.
The state then gives each owner a credit for their share of the tax the entity paid, so the owner owes little or no state tax on that income personally. The net effect is a federal deduction for state income tax that the cap would otherwise have disallowed.
The 2025 tax law raised the individual cap but contains no provision limiting this entity-level deduction.
Who benefits, and who does not
Whether it is worth electing depends on the owners, not the business:
- Benefits most: owners of profitable partnerships and S corporations whose state and local taxes already exceed the cap, and high earners whose cap has shrunk toward $10,000.
- Benefits little: owners who take the standard deduction, or whose total state and local taxes fit under the cap anyway.
- Not available to sole proprietors and single-member LLCs taxed as disregarded entities, because there is no separate entity to pay the tax.
- Worth checking with every owner: the election is made for the whole entity, and an owner who lives in another state may get less from the credit.
Illinois pass-through entity tax
Illinois partnerships (other than publicly traded ones) and S corporations can elect to pay a tax of 4.95% of their net income. The election is made separately for each year on the return, Form IL-1065 (Line I) or Form IL-1120-ST (Line L), and cannot be revoked once made. Each owner then gets a credit against Illinois income tax of 4.95% of their distributive share, but no more than their share of the tax the entity actually paid.
The tax was originally limited to tax years beginning before January 1, 2026. Public Act 104-0453, effective December 12, 2025, removed that end date, so it now applies for as long as the federal SALT cap does. A nonresident owner whose only Illinois income comes from the electing entity does not have to file an Illinois return if the credit covers their tax.
An electing entity makes estimated payments if its tax is expected to exceed $500, due on the 15th day of the 4th, 6th, 9th and 12th months of its tax year, and pays any balance by the original due date of the return even if it extends. The 1.5% Illinois replacement tax is separate and still applies.
Before you elect
A few practical points:
- Run the numbers both ways: the federal saving is the state tax times the owners’ federal marginal rate, only for owners over the cap.
- Plan the cash: the entity pays the tax and its estimated payments, not the owners.
- Check every owner’s home state for the credit, and the partnership or operating agreement for who bears the cost.
- Remember the election is annual and, in Illinois, irrevocable for the year.
Should your business elect PTET?
Our tax planning assessment runs the election both ways on your own numbers, for every owner, before the deadline. $195, in person in Naperville, IL, by phone or by Zoom.
Questions people ask
What is PTET?
A pass-through entity tax: a state income tax that a partnership or S corporation elects to pay itself, so it can deduct the tax federally without the owners’ SALT cap. Owners get a state credit for their share.
Is PTET still worth it after the SALT cap went up to $40,000?
For many owners, yes. The cap is $40,400 for 2026 but shrinks by 30% of income above $505,000, down to $10,000 at about $606,000 of modified AGI. Owners above the cap still lose deductions that PTET recovers.
What is the Illinois PTE tax rate?
4.95% of the electing partnership’s or S corporation’s net income, the same as the individual rate.
Does the Illinois PTE tax expire?
Not any more. Public Act 104-0453 removed the original end date for tax years beginning on or after January 1, 2026. It now applies while the federal SALT cap applies.
Can a single-member LLC elect PTET?
Not while it is a disregarded entity. Illinois allows the election only for partnerships and S corporations, so a single-member LLC would first need to elect S corporation status.
Where these rules come from
- IRS Notice 2020-75
- Public Law 119-21, section 70120 (SALT cap)
- IRS: Instructions for Schedule A (2025)
- Illinois: 35 ILCS 5/201(p), pass-through entity tax
- Illinois Public Act 104-0453
- Illinois DOR: Form IL-1065 instructions
- Illinois DOR: Form IL-1120-ST instructions
General information, current when written, not advice about your situation. Fees and forms change; the official pages above are the authority.
