A growing list of states have enacted laws allowing pass-through entities (PTE) to elect into pass-through entity tax regimes as a workaround to the $10,000 federal cap on state and local tax deductions for individual taxpayers. Under these regimes, the PTE pays its owners’ state taxes and takes a deduction equal to the tax paid, while the owners receive a credit or exclusion of state income equal to their state tax liability. Because the SALT cap doesn’t apply to taxes assessed at the entity level, the PTE can typically take a federal deduction for its entire PTET payment.
The IRS provided guidance on the federal tax treatment of PTET payments in November 2020. However, questions remain regarding the tax implications of PTET elections, particularly in M&A transactions. The effect a PTET election has on a transaction depends on many factors, including the applicable state PTET law, timing of the PTET deduction, type of PTE entity involved, and whether assets or ownership interests are being sold or purchased.
