The Elective Pass-Through Entity Tax and Your Childcare Business

January 15, 2024

Are you the owner of a pass-through entity childcare business? If so, then you may want to consider whether taking the elective pass-through entity tax offered by your state is the right tax strategy for you. In the following guide, learn about the elective pass-through entity tax, its advantages and disadvantages, and how to take it.

What is the elective pass-through entity tax?

In order to understand the elective pass-through entity tax (PTET), you first need to know about the state and local tax deduction, also known as the SALT deduction. This tax deduction allows certain taxes paid to state and local governments to be listed as itemized deductions on the taxpayer’s federal income tax return. Before 2018, the SALT deduction was unlimited, but the Tax Cuts and Jobs Act of 2017 placed a $10,000 cap on the SALT itemized deduction ($5,000 for individuals Married Filing Separately) effective for 2018 through 2025.

The SALT deduction applies to taxes paid to state and local governments in the form of income taxes, property taxes, or sales taxes, but the $10,000 limit enacted in 2017 quickly became an unfavorable drawback that many states have since tried to work around—that’s where the elective pass-through entity tax comes in.

The PTET allows eligible pass-through entities, including partnerships and S Corporations, to elect to be taxed at the entity level for the purpose of state income taxes.

Here’s what the PTET accomplishes for the taxpayer:

If an entity makes this election, then the partner or shareholder is allowed to:

  1. Claim a PTET credit on their state individual income tax return equal to the amount of their distributive share of the PTET paid by the entity; or,
  2. Forgo reporting the distributive share of income on their state individual income tax return

Which states offer an elective pass-through entity tax?

As of 2023, 34 U.S. states have enacted legislation for an elective PTET.

The following states put in place a PTET before 2022:

  • Alabama
  • California
  • Connecticut
  • Idaho
  • Illinois
  • Louisiana
  • Massachusetts
  • Maryland
  • Minnesota
  • New Jersey
  • New York
  • Rhode Island
  • South Carolina
  • Virginia
  • Wisconsin

The following states created a PTET that went into effect in 2022:

  • Arkansas
  • Arizona
  • Colorado
  • Georgia
  • Kansas
  • Michigan
  • Mississippi
  • New Mexico
  • North Carolina
  • Ohio
  • Oklahoma
  • Oregon
  • Utah

The following states enacted a PTET in 2023 that is also retroactive for 2022:

  • Indiana
  • Iowa
  • Kentucky
  • West Virginia

Finally, the following states passed legislation for a PTET to go into effect beginning in 2023:

  • Hawaii
  • Missouri

In order to learn about the pass-through entity tax laws that apply in your state, you’ll need to visit your state’s Department of Taxation and Finance website.

What are the advantages and disadvantages of the elective pass-through entity tax?

The major advantage of the elective pass-through entity tax to the taxpayer is a legal workaround to the federal $10,000 cap on the SALT deduction.

There are no major disadvantages to the elective pass-through entity tax, but PTE owners should be aware of the following considerations:

  • Possibility of some owners benefiting disproportionately from the credit, thereby changing a pre-existing agreement among partners/owners
  • Possibility of tax consequences to owners in their home state if that state does not allow resident taxpayers to claim a credit for their share of taxes paid to another state by the PTE
  • Additional administrative, legal, or accounting fees

How to elect the pass-through entity tax

How to elect the PTET will depend on your resident state and its rules.

For example, in New York State, an authorized person can opt in to the PTET on behalf of an eligible entity through the entity’s Business Online Services account.

We recommend reviewing your eligibility for the PTET under the rules of your resident state with a qualified tax professional.

We hope this guide to the elective pass-through entity tax proves helpful to your own Early Childhood Education business tax strategy.

Reach out to the experts at Honest Buck to learn more about tax credits, deductions, and planning tools for your childcare business.

Share this article