The SALT Cap Workaround: Pass-Through Entity Tax
How more than 30 states let a partnership or S corporation pay state income tax at the entity level, why the 2025 law kept the workaround alive, and what it means for Florida businesses with income elsewhere.
Reviewed by the Fairlight Accounting cross-border tax team — U.S. & Canadian Tax Desks
A pass-through entity tax lets a partnership or S corporation pay state income tax at the entity level, where it is a deductible business expense, instead of at the owner level, where the deduction is capped. The 2025 law raised the cap but kept the workaround, so it still pays for higher-income owners.
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Why does it work?
The federal deduction for state and local taxes on an individual's Schedule A is capped. A tax paid by the business is not subject to that cap; it reduces the income passed through on the K-1. Most electing states then give the owner a credit or exclusion for the entity-level tax, so the state tax is paid once. The IRS confirmed the treatment in Notice 2020-75.
What did the 2025 law do?
| Item | Rule |
|---|---|
| Cap for 2025 | $40,000 (joint and single; $20,000 married filing separately), up from $10,000 |
| Cap 2026–2029 | $40,400 for 2026 ($20,200 married filing separately), then up 1 percent a year through 2029 |
| Phase-down | Cap reduced by 30 percent of modified adjusted gross income above $500,000 for 2025 ($505,000 for 2026, then up 1 percent a year; half for married filing separately), but not below $10,000 — reached at about $600,000 for 2025 and $606,333 for 2026 |
| 2030 and later | Cap returns to $10,000 |
| Entity-level tax | Not restricted — earlier proposals to limit the workaround were dropped |
Owners above the phase-down income, and owners whose state tax exceeds the cap, keep the full benefit from the election. Because the entity-level tax also lowers the owner's adjusted gross income, it can pull an owner back under the phase-down threshold.
How does the election work?
Each state sets its own rules: an annual election, often due with the return or by a mid-year date; estimated payments; and treatment of nonresident owners. Common differences include whether the election is binding for all owners, whether nonresident owners are covered, and whether the credit at the owner level is refundable. For a cash-method deduction, the entity must pay the tax by December 31.
What about Florida businesses?
Florida has no personal income tax, so it has no pass-through entity tax. The election matters for Florida-based partnerships and S corporations with income taxed in other states — a New York, New Jersey, California, or Georgia office or project — and for owners who live in those states. The entity-level payment reduces the federal income passed through to every owner, so Florida residents get a full federal deduction for the other state's tax instead of a capped Schedule A deduction for their nonresident tax.
When does the election not help?
When the owners' total state and local taxes already fall under the cap, when the state's credit is less than the tax paid, or when some owners are tax-exempt or nonresidents the state does not cover. Owners who do not itemize still benefit, since the deduction is taken above the line at the entity.
Frequently asked questions
Does the entity tax reduce qualified business income?
Yes. It is a deduction at the entity level, so it lowers both the income passed through and the qualified business income deduction base.
Can a single-member LLC elect?
Not while it is disregarded for federal tax purposes — the election is for entities taxed as partnerships or S corporations. A single-member LLC that has elected S corporation status generally can, since states such as California do not require more than one owner.
Does it affect the owner's estimated taxes?
Yes. Lower K-1 income reduces federal estimates; state estimates move to the entity.
What if the owner later sells the business?
The election applies to operating income, and many states also apply it to gain on an asset sale passed through to owners, which can be a large benefit in the year of sale. Gain on selling the ownership interest itself is the owner's and falls outside the election.
Official sources
The IRS explains: “Any Specified Income Tax Payment made by a partnership or an S corporation is not taken into account in applying the SALT deduction limitation to any individual who is a partner in the partnership or a shareholder of the S corporation.” — Internal Revenue Service, Notice 2020-75, Forthcoming Regulations Regarding the Deductibility of Payments by Partnerships and S Corporations for Certain State and Local Income Taxes, https://www.irs.gov/pub/irs-drop/n-20-75.pdf
The statute provides: “the aggregate amount of taxes taken into account under paragraphs (1), (2), and (3) of subsection (a) and paragraph (5) of this subsection for any taxable year shall not exceed the applicable limitation amount (half the applicable limitation amount in the case of a married individual filing a separate return).” — Legal Information Institute, Cornell Law School, 26 U.S. Code § 164 - Taxes, https://www.law.cornell.edu/uscode/text/26/164
Next step
Fairlight Accounting handles U.S. domestic, cross-border (U.S.–Canada), and international tax returns, plus bookkeeping, payroll, and CFO advisory. Our U.S. Tax Desk tracks each state's election deadline and runs the owner-by-owner benefit before electing. See pricing or book a free fit call.
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