By Dr. James M. Dahle, WCI Founder
As part of the Tax Cuts and Jobs Act (TCJA) of 2017, a limitation was placed on a very important itemized deduction for doctors and other high-income professionals: the State And Local Tax (SALT) deduction.
Before the TCJA was passed, the SALT deduction was unlimited. As part of TCJA, a cap of $10,000 per year was placed on the deduction of state and local taxes from your federal return. This includes property taxes, as well as the taxpayer's choice of state and local income taxes or sales tax.
You can see this limitation on line 5e of the 2021 Schedule A of Form 1040.
But there is a way around the SALT cap, and it's known as PTET.
A History Lesson on the SALT Cap
The main reason the SALT cap was included was because the TCJA was passed through the Senate via the reconciliation process. Reconciliation requires only a majority vote rather than the filibuster-proof 60/40 vote, and the supporters of the bill (essentially Republicans) didn't have 60 votes. Under current rules, the reconciliation process in the Senate is not allowed to increase federal deficits, so to pay for the other tax cuts, this tax increase (in the form of a decreased deduction) was included. The process also required the entire act to sunset at the end of 2025 if Congress does not extend it. So, these laws are essentially in place from 2018-2025.
The more cynical among us viewed the SALT cap as Republicans sticking it to Democrats because taxpayers in Democratic-controlled “blue” states were far more likely to have high property values (and thus high property taxes) and state and local income taxes. In essence, Democrat voters now had to pay a slightly higher percentage of the costs of the federal government than they did before. Nobody likes paying more in tax, especially when they feel like they're paying more than their fair share. Right away, attorneys, accountants, politicians, and taxpayers in blue states began trying to get around the SALT cap.
However, reducing our personal income tax bill is hardly a partisan activity, and taxpayers and politicians in all states eventually jumped on board.
The first idea was to give taxpayers a tax credit for donations they made to state-supported causes. Essentially, the state tax commissions were masquerading as charities. Predictably, the IRS quickly put an end to that idea.
However, the next idea was a lot more legally viable.
Initially started in Connecticut as a mandatory tax, it quickly spread to dozens of other states in the form of an elective tax. This is known as a Pass-Through Entity Tax (PTET). A pass-through entity is a form of business, including sole proprietorships, partnerships, and S Corporations (as well as Limited Liability Companies [LLCs] that elect to pay taxes as a sole proprietorship, partnership, or S corporation), that passes through its income and tax obligations to its individual owners to pay on their personal income tax return.
This is to distinguish these entities from a C corporation that pays taxes on its own tax return. The idea here is that the pass-through entity, either mandatorily in Connecticut or voluntarily in other states, pays the state income taxes on behalf of the owners. Now the state income taxes become a business deduction. You do not pay federal income taxes on business deductions. The state then gives the owners a tax credit for the payment. The net effect is that the state income taxes are once again fully deductible on your federal income taxes.
Needless to say, it was not initially clear whether this was going to be legal. However, on November 9, 2020, the IRS issued Notice 2020-75. Here's the meat of it:
In essence, the IRS blessed the technique, at least for partnerships and S Corps (and, of course, LLCs that file as partnerships or S Corps). Those states that had already implemented a PTET were pleased and many of those who had not (including my state of Utah) began working on legislation to implement one.
Every State Is Unique
Naturally, every state is different, and so every law is different. If you're interested in taking advantage of this law, you'll need to understand the specifics of your state's new law and make sure you comply with it. The tax may be mandatory or voluntary. It may provide an exclusion, or it may provide a credit. The details all matter and this blog cannot cover the exact law for every state.
How Much Is the PTET Worth?
How much money could taking advantage of the PTET save you on your federal income tax bill? Well, it depends. Let's do a few case studies that will demonstrate the value to a given taxpayer. For each, let's assume the taxpayer is already paying $10,000 in property tax.
Case #1: Two-Employee Physician Family
This family has a combined taxable income of $500,000. Since they are both employees, there is no pass-through entity involved.
Tax savings? $0
Case #2: Texas Doctor
Dr. Rodriguez hates paying taxes, so he moved to Texas a few years ago to avoid state income tax. Since Texas doesn't have a state income tax, it hasn't bothered (and won't bother) to implement a PTET.
Tax savings? $0
Case #3: Pediatric Partnership in Utah
Drs. Smith, Jones, and Nebeker are partners in a pediatric practice in Utah. Once Utah's law was passed, they quickly took advantage of it and paid the voluntary PTET. Dr. Jones estimated his state income tax liability at $252,000 * 4.85% = $12,222, so that's what his share of PTET was. His wife does not work so they are in the 24% federal income tax bracket. They give 10% of their income to charity each year, and they itemize their deductions.
Tax savings? $12,222 * 24% = $2,933 (It'll actually be less as it will reduce their 199A deduction, see below)
Case #4: ENT in New York
Mary is killing it as an ENT in upstate New York. Her taxable income this year will be $800,000. She has already formed an S corp to save some Medicare tax. She estimates her state income taxes as $53,154 and pays that via the S Corp as PTET. She is her favorite charity so she doesn't itemize given that her only itemized deduction is her $10,000 property tax bill. She is in the 37% federal income tax bracket.
Tax savings? $53,154 * 37% = $19,667
Case #5: Successful Tech Entrepreneur in California
Ivanna and Nikolai live in California, and they've built a successful tech company. It is an LLC taxed as an S Corp. Last year, the S Corp distributions were $5 million in addition to their salaries (aka guaranteed payments of $1 million total). California allows them to pay 9.3% of their distributions and guaranteed payments as a PTET, for a total of $558,000. They are in the 37% federal income tax bracket.
Tax savings? $558,000 * 37% = $206,460 (It'll actually be less as it will reduce their 199A deduction, see below)
How Can You Take Advantage of the PTET?
First, become familiar with your state law. Unless Congress changes the rules, this is only going to work for the next four years (2022-2025).
Second, if your business structure does not currently qualify for this deduction, evaluate whether the hassle and cost of changing it will be worthwhile. If so, start making that change.
Third, if your business does qualify (or you have changed it to qualify), contact those in charge (such as the CFO or accountant) to ensure that a PTET payment is actually made before the end of 2022.
Fourth, be sure your tax forms are filled out correctly to ensure you get the credit or exclusion you are entitled to on your state income taxes.
Where Does the Tax Deduction Get Reported to the IRS?
This shows up on your partnership or S Corp return. For example, on an S corp return, it goes on line 12.
This is not part of your federally taxable income, and thus, it's not taxed at the federal level. However, it should show up on your state K-1 so that you can claim it as a credit or exclude it from income.
Can I Pay More State Tax Through My Pass-Through Entity Than I Would Have to for That Income?
Let's say you have a side gig, and it will qualify to pay PTET. Can you pay EXTRA PTET to “cover” your W-2 income? Again, you'll need to look carefully at your state law, but I would not expect it to do so. For example, the California law limits the amount of PTET you can pay to the guaranteed payments and distributions of that entity.
Utah's law is similar. The tax is imposed on voluntary taxable income, defined as the sum of a pass-through entity's income that is
a) attributed to a final pass-through entity taxpayer who is a resident individual and
b) business income and nonbusiness income that is derived from or connected with Utah sources that is attributed to a final pass-through entity taxpayer who is a nonresident individual.
I am not 100% certain, but I believe that S corp distributions and partnership guaranteed payments count but that S Corp salaries do not.
I Work Solo. Can I Still Qualify for PTET?
A sole practitioner or independent contractor could still qualify (in most, if not all, states) by forming an S corporation. This may also save you some Medicare tax.
How Will PTET Affect the 199A Deduction?
Naturally, there is a downside. If you qualify for the 199A deduction (i.e. the pass-through business deduction) on your federal taxes, paying PTET is going to reduce that. Highly paid physician practices (such as case study #4 in the above example) aren't generally eligible for this deduction, but many other businesses, such as The White Coat Investor, are. Your 199A deduction is limited to 20% of Ordinary Business Income (and further limited to 50% of salaries paid). Every dollar paid in PTET reduces Ordinary Business Income (OBI) by a dollar. Let's use an example to demonstrate.
Let's say Billy Bob has a tractor business in Utah that makes $1 million in OBI. He normally gets a $200,000 199A deduction on his federal taxes. However, now that Utah has passed this PTET rule, he decides to check it out. He will be paying 4.85% * $1 million = $48,500 in PTET taxes. This now reduces his OBI by $48,500, to $951,500, and thus reduces his 199A deduction by $48,500 * 20% = $9,700. So instead of getting an extra $48,500 deduction, he really only gets a
$48,500 – $9,700 = $38,800
deduction. It's still worth doing, but it's not quite as good as he had initially hoped.
Is This Good Tax Policy?
Are you kidding? Of course not. This is a tax policy travesty. We have states circumventing federal tax policy that nobody actually wants in the first place but had to implement due to rules passed because Congress can't figure out how to pass bipartisan legislation. Now we have to keep track of 50 different sets of tax laws instead of one.
This is even worse for those of us who are partners in businesses in multiple states. For example, I can get this deduction on my income from WCI (a Utah LLC) but not Passive Income MD (a Wyoming LLC). The PTET SALT cap workaround might be legal and ethical, but it's a tragedy that this is even necessary. Deductions, exclusions, and credits are, by their very nature, “not fair.” A fair tax policy would eliminate all the deductions and just lower the overall tax brackets for everyone. But the tax code is used for a lot of things in our society besides just raising revenue for the government. It is used to implement social policy, run a welfare system, and encourage certain behaviors. Governing a republic is messy, and nowhere is it messier than in tax policy.
Is PTET Retroactive?
In many states, yes. Laws passed in 2021 or 2022 are retroactive to tax year 2018. Read up on your state's law for details.
Does PTET Work for Passive Income?
Double-check your state law, but I have not yet seen one that excluded partnerships with passive partners from doing this. If your partnership elects to pay PTET, it should pass through to you.
Are Trusts Eligible for PTET?
Again, consult your state's specific law. Some (such as New York) specifically exclude trusts, but Utah (thank goodness) specifically includes them.
Which States Have Implemented PTET So Far?
This list is obviously rapidly changing and will soon be out of date (if it is not already). If you see an error, let us know in the comments so we can fix it.
States That Don't Have PTET
These states don't need to pass a PTET law since they do not have a state income tax.
- Alaska
- Florida
- Nevada
- New Hampshire
- South Dakota
- Tennessee
- Texas
- Washington
- Wyoming
PTET States
These states have passed a PTET law. The link provides additional information.
- Alabama
- Arizona
- Arkansas
- California
- Colorado
- Connecticut
- Georgia
- Idaho
- Illinois
- Iowa
- Louisiana
- Maryland
- Massachusetts
- Michigan
- Minnesota
- New Jersey
- New York
- North Carolina
- Ohio
- Oklahoma
- Oregon
- Pennsylvania
- Rhode Island
- South Carolina
- Utah
- Virginia
- Wisconsin
No PTET States
These states have not yet passed a PTET law. Most probably will soon, although I wouldn't expect it from Kansas—which doesn't actually tax pass-through income.
- Delaware
- Hawaii
- Indiana
- Kansas
- Kentucky
- Maine
- Mississippi
- Missouri
- Montana
- Nebraska
- New Mexico
- North Dakota
- Vermont
- West Virginia
The PTET is an important tax-saving technique for eligible white coat investors all over the country. Figure out today if you are eligible or can become eligible.
If you need help with tax preparation or you’re looking for tips on the best tax strategies, hire a WCI-vetted professional to help you figure it out.
What do you think? Will you be paying PTET? Anything unique about your state in this regard? Comment below!
This is a timely article Jim.
For those folks who are in California, the first deadline for ~50% of your PTET contribution from your passthrough entity to the Franchise Tax Board is due Wednesday, the 15th of June. The second payment is due no later than the tax filing deadline for your corporation (typically March 15th next year).
More timely than I thought!
Indeed, extraordinarily timely and very much appreciated, Jim. Am suspecting you may be unilaterally responsible for a great many of these filings this year!
Following on Hank’s comment, the California Franchise Tax board rules state that payment 1 is due on the 15th of June not of the year taxes will be paid, but of the originating tax year. So your timing is phenomenal.
Here’s my question for anyone who has done this. Payment 1 dues in CA are: “$1,000 or 50% of the elective tax paid for the prior taxable year, whichever is greater.” If this is my first year trying PTET for the S-corp, my interpretation is that the *elective* tax for the prior year was 0, thus I could get away with paying $1,000 now as a placeholder and then truing-up at the end of the year.
Do others agree? Or is the general consensus that my entity should pay 50% of what last year’s PTET *would* have been (ie, 50% of all S-corp related W2 + distributions for all eligible taxpayers) had I elected to maximize it? This will be a non-issue in future years, just want to get it right the first time and not pre-pay the larger amount if not necessary.
Thanks everyone.
Answering my own question here – most CPA/JD blogs I’ve found in the last 15 min agree with the former interpretation — namely that if you did not take advantage of PTET in 2021, then your elective tax was 0, and thus 2022’s payment #1 minimum can be a flat $1,000. Works for me.
As an aside, it was a bit confusing reading through the original bill as in California traditionally “qualifying net income” of a PTE does not include guaranteed payments (ie W2 for your S corps). From what I’ve gathered since the last post, that was actually a specific change made in the relevant law passed in California – namely to override this restriction for the purposes of this SALT loophole and specifically allow taxpayers to include their W2 salaries for S-corps.
PWC had a brief description of this here: https://www.pwc.com/us/en/services/tax/library/california-makes-changes-to-pte-tax-and-2022-nol-credit-limits.html “Guaranteed payments: Section 19900 of the Revenue and Taxation Code defines “qualified net income” of a qualified entity to mean the sum of the pro rata share or distributive share of an electing partner’s income. The California Franchise Tax Board published a frequently asked question on its website stating “Guaranteed payments are not considered part of an entity’s qualified net income because they are not part of the distributive share for purposes of the PTE elective tax,” excluding guaranteed payments from the definition of “qualified net income.” **SB 113 expands the definition of “qualified net income” to specifically include guaranteed payments.**”
Jim’s post nicely adds this to the example of the California tech entrepreneur, though I didn’t realize this was actually a benefit over and above what had originally been proposed with CA PTET deductions.
Seems right to me that you could just pay $1,000.
Very interesting loophole. Wondering how does this works if we have been paying escrow and the mortgage servicer pays the property tax bill? Since the 1099 is issued to me, the individual taxpayer, do we need to somehow have the servicer issue a 1099 for the property tax payments by the S corp? How do we get them to recognize payment from the S corp? Do we pay the tax from the S corp directly to the county tax commissioner, tell the servicer that the taxes were paid and request the escrow be recalculated, getting our tax escrow refunded? Would appreciate additional info about the logistics of this when using escrow. Thanks very much.
I don’t think this is going to work for property taxes, only income taxes.
IN New York….can you do this PTET thing even with just a sole proprietorship and EIN? Or do you have to open an S corp or LLC?
Thanks
No, you will need an S Corp or partnership:
https://www.tax.ny.gov/bus/ptet/
Is this worth it in CA? I’m an independent contractor working in a hospital in CA. 75% of my income is direct from insurance company/patient billings. The other 25% is from a medical director stipend.
Originally I set up my practice as a sole proprietor–it’s just simpler. It’s also hard to claim any of my income as distributions since I’m literally being paid what insurance companies have agreed to pay me (as well as the company that provides my stipend, as it’s structured as an hourly payment). Plus, CA taxes S-corps an extra 1.5% on net proceeds (so all my net income). Physicians cannot file as LLC’s in CA.
Unfortunately sole proprietorships are not eligible to pay state taxes via PTET in CA.
I average $22,000-$25,000 in CA state taxes per year. County taxes are another $7500-ish, and I’m not sure those are applicable with PTET. I itemize my deductions as we give a fair amount to charity, and my mortgage interest paid per year is high as we’re in a high COL area. So I hit the $10,000 SALT deduction limit .
Still, am I wrong to still say it’s not that much worse to file as a sole proprietor? If I have to pay another 1.5% tax on say $350k, that’s a bit over $5000. 32% (my tax bracket) of $25,000 (CA taxes) + $7500 (county) saves me $7200 from federal taxes, correct?
So all that best-care scenario (I estimated earnings for a good year), and all the extra effort/hassle of filing as an s-corp, plus the hassle of paying the PTET, I save perhaps $2500. Minus the additional accounting fees since now I’d be an s-corp. So maybe $1000. Maybe zero.
As you mention PTET 199a pass-through deduction. Between my health insurance, 401, etc., I don’t get phased out of that currently.
Am I grossly miscalculating something here? I like to keep things simple in life, so simplicity and being able to continue doing my own taxes is worth missing out on that $1000.
Sounds like you’ve thought it through well although I didn’t hear you mention any tax savings on Medicare tax from the S Corp.
If you do a fair bit of charitable giving, you might want to bundle two or three years’ worth of charitable gifts into a one year contribution to a donor advised fund, then take the standard deduction the other year or two years. If you have highly appreciated assets in a taxable brokerage account, donate those shares instead of donating cash.
It isn’t entirely clear if it would be worth the trouble to incorporate in California given your income and the relatively few years remaining for this tax loophole.
So if you fall into the 1099 bucket, then your benefit would be:
(Marginal Tax Rate- 20%) x State Taxes.
If you’re in the 24% marginal rate, it would be 4% times state taxes paid. I’ll take it, but it’s not that great.
Is this correct?
Also, what about the SSA 2.9% tax and the medicare 0.9% tax. Wouldn’t these also contribute to the savings?
I’m having trouble following you. Can you provide more detail?
Sorry my mistake, my logic was off.
Jim! As mentioned above the filing deadline for this in California is literally tomorrow! You sure got my adrenalin up buddy. I barely made it. Thanks for the $800 (for this year, the next 3, and maybe more)!
Good info. KS actually does tax pass through income now. State tax revenue plummeted when they stopped taxing pass thru income as everyone and their dog formed an S corp. So they repealed it several years ago.
Thanks for the correction.
We’re a blog/multi-media firm, not a law firm. We don’t have a single attorney on staff.
Just as a mental exercise to make sure I understand this correctly…
State: PA (3.07% income tax)
W2 income: $500,000 (healthcare)
Sole Proprietor Income: $175,000 in healthcare (employed spouse at $50,000 salary)
Marginal tax rate: 39%
Assume no 199A deduction due to healthcare
In this scenario, one could convert the sole proprietorship to an S Corp.
Total S corp. income would then be considered $125,000 ($175,000-$50,000 spouse salary) with state income tax owed of $3837 ($125,000 x 3.07%) on this income
S corp can voluntarily pay this income tax on behalf of the individual creating a $3837 federal deduction ($1497 tax savings).
On top of this, individual is able to claim the $10,000 SALT deduction on their W2 income.
Does this seem accurate?
How do you get 39% marginal tax rate with 3% Pennsylvania tax? There is no 36% federal tax bracket.
It’s a little squirrely not paying yourself a salary from your S corp either.
But yea, your math looks right.
Just a heads up, but the ptet for Iowa is limited to only centralize audit changes (so you need to have a federal election in place and is only for tax changes due to a federal audit). There was a proposed bill to expand it to all entities i n the 2022 legislative session , but it didn’t make it out of committee afaik.
I’ve heard rumors that you can’t pay Utah state tax at the PTE level if the income is derived from capital gains or dividends. Knowing you’re a fellow Utahn, do you know whether this is accurate?
The business can only pay PTE tax on the income from the business, not on your employee income or unearned income.
I think Example 4 is in error. I’m trying to decide if I S-Corp, and both accountants I’ve talked to say you can only reduce the fed tax on the distribtuion.
E.g. $600k 1099 physician, solo S-Corp.
Reasonable Salary = $300k. Pay ADP payroll service to cut your checks as a W2 = pay state and fed taxes on this.
Distribution = $300k. SCorp can pay state taxes on this, reducing the amount the fed tax is on. Also save the 1.5% medicare tax.
Still worth it, but you’re not spared the double taxation on the “reasonable salary” part of your pay.
I’m not hearing anything in your comment that sounds wrong. Can you point out what in the post is in error?
Looking at your Case #4: ENT in New York, I think her tax savings is lower since a PTET can only pay state tax on your distribution, and not the “reasonable” W2 salary it has to pay you.
Taxable income $800k. SCorp. $53,154 state tax paid via the S Corp as PTET (6.6%). 37% federal income tax bracket.
The SCorp has to pay her a “reasonable salary.” Call it $400k for an ENT (though I know some aggressive folks do $200k). So she pays state and fed on $400k (double taxed). This leaves 400k for S Corp to distribute, and pay 6.6% state tax, and deduct from fed. That’s $26400.
So tax savings is 26400 x 37% = 9768, not the $19,667 in the example.
Granted, Mary would also save the 1.5% Employer medicare tax on the 400k distribution = 6000.
Thanks for clarifying. You’re right that an S Corp must withhold state taxes on wages and that those aren’t deductible.