Quadrupling SALT Cap May Vex States With Passthrough Entity Tax

Republicans’ plan to quadruple the federal government’s state and local tax deduction cap to $40,000 could lessen the federal tax benefits in states that have adopted passthrough entity taxes.

This in turn may prompt state lawmakers, who adopted PTET regimes to circumvent the existing $10,000 cap, to reevaluate their effectiveness and future viability.

PTET regimes allow certain entities to pay state taxes at the entity level, enabling owners to sidestep the cap created by the 2017 Tax Cuts and Jobs Act. However, the bill proposes extending the SALT deduction cap to taxes paid on income from investment activities and specified service trades or businesses, such as doctors, attorneys, and accountants.

If implemented, this could lessen the federal tax benefits of state PTET regimes, potentially prompting state lawmakers to reevaluate their effectiveness and future viability.

The debate over the SALT deduction cap is ongoing. The primary beneficiaries of the increased SALT deduction caps are residents of high-cost-of-living areas such as New York City and Los Angeles. As a result, Republicans from these regions argue that not addressing the cap could threaten the GOP’s hold on the House majority in the 2026 midterms. Conversely, Republicans from lower-tax states believe raising the cap encourages high-tax policies in blue states and primarily benefits affluent residents in those areas.

The current SALT cap is generating less federal tax revenue than anticipated, largely due to state PTET regimes. Placing additional limits on the cap, such as gross income or type of income, could help increase the tax revenue that the federal government collects. Some state PTETs are set to sunset regardless of federal changes, while others are contingent on the SALT cap or are designed to be permanent.

Although most states’ PTETs will remain in effect if the federal election expires, six states (including Illinois) tie their PTET to the duration of the SALT cap, and four states (including California) limit the PTET election to tax years before 2026.

Even in states that offer the PTET election indefinitely, the potential elimination of the federal SALT cap may prompt pass-through entities to reevaluate the benefits of making the election. The time and additional effort required to file extra returns and make payments might no longer justify the election if the SALT cap is increased or eliminated.

Paying taxes at the partner level could become more advantageous in such scenarios. In states where the SALT cap is directly tied to the TCJA’s $10,000 limit, there could be a period of uncertainty as states consider action to maintain their PTET regimes.

This could lead to issues with taxpayers’ ability to make estimated payments or timely elections. It will be crucial for taxpayers and tax practitioners to stay updated with those state changes to avoid losing a lucrative benefit.

Even if the SALT cap expires, elective state PTET taxes could still offer federal benefits for taxpayers subject to the alternative minimum tax, allowing them to deduct trade or business SALT expenses as above-the-line deductions.

The potential changes introduced by this bill will influence both federal and state tax policies, with significant consequences for taxpayers across the country. As lawmakers continue to negotiate the terms, balancing fair tax practices and addressing regional cost-of-living disparities will be central to the debate.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

John Bonk is managing director of state and local tax at CBIZ.

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