On June 16, 2025, the Senate Finance Committee released a draft package that includes a major provision aimed at curbing the use of state pass-through entity taxes (PTETs) to bypass the federal $10,000 cap on state and local tax (SALT) deductions.
The proposal, found in Section 70601 of the bill, would limit the ability of individuals to deduct PTET payments, disallow federal deductions for PTETs in certain jurisdictions or with inflated rates, and introduce new rules to prevent workaround arrangements designed to avoid the SALT cap.
Key SALT-Related Provisions
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Retains the $10,000 Cap
The bill retains the $10,000 SALT cap of the TCJA on a permanent basis, in contrast to the House bill, which would raise it to $40,000. This provision can be expected to be revised as the House and Senate bills seek reconciliation.
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Cap on PTET Deductibility
The bill would require partnerships and S corporations to treat PTETs as separately stated items and impose a new limit on how much of such a separately stated PTET item an individual taxpayer can deduct by adding a new ceiling. Under the proposal, an individual’s total SALT deduction, including any PTET passed through to them, would be limited to:
- The regular $10,000 cap on SALT deductions ($5,000 for married filing separately), plus
- The greater of:
- $40,000 ($20,000 for married filing separately), or
- 50% of the total PTET paid on their behalf.
This would significantly reduce the benefit of PTET elections in high-tax states or for high-income individuals.
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Allow PTET Deduction for Service Businesses
Under the House bill, the benefit of the SALT cap workarounds would be available only for those pass-through entities that carry on IRC Section 199A qualified trades or businesses. The effect would be to disallow the deduction for PTETs paid by various service-based businesses, including law and accounting firms, investment firms, consulting firms, and medical practices.
The Senate bill drops this approach, thus leaving PTET workarounds available for all types of trades or businesses, but subject to the new caps otherwise imposed by the bill on such workarounds.
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PTETs That Fail New Federal Eligibility Criteria Will Be Excluded from the Deduction
For tax years beginning more than 18 months after the law is enacted, a PTET will not qualify for the federal deduction available for PTET payments if:
- The jurisdiction does not impose an individual income tax (e.g., Texas, Tennessee, Florida), or
- The PTET liability exceeds 102% of what an unmarried individual would pay on an equivalent amount of income under that state’s tax laws.
PTETs that fail either test are expressly excluded from the federal definition of PTET governing deductibility. As a result, those payments will not be deductible under the rule established in the Senate bill. This limitation appears intended to prevent aggressive PTET structures in states with no personal income tax or inflated entity-level rates.
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New Guardrails for SALT Workaround Structures
The bill would also disallow deductions for “substitute payments,” arrangements where a taxpayer or a related entity pays an amount to a state and receives a tax benefit, such as a credit or exclusion, worth at least 25% of that amount. The Treasury would be authorized to issue regulations targeting similar workaround schemes.
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What This Means for Taxpayers
The vast differences between the House and Senate versions leave us with uncertainty as to just which provisions of each bill will make it into the final legislation. But regardless of the outcome, the final version can be expected to significantly limit the usefulness of PTET elections. It would also impose new federal rules governing how state taxes are deducted, irrespective of how they are structured at the state level.
Taxpayers with PTET elections in place, or evaluating elections, should continue monitoring this legislation and assess how much of their PTET deduction could be disallowed under the new rules.