[author: Tenzing Tunden]
This is the first installment in a three-part series exploring the key implications of the One Big Beautiful Bill Act (OBBBA).
On July 4, 2025 the One Big Beautiful Bill Act (OBBBA) was signed into law.[1] The OBBBA made several provisions permanent from the Tax Cuts and Jobs Act (TCJA). It also made significant changes aimed to expand deductions, incentivize investments, and provide long-term clarity for tax planning for individuals and businesses. These issues were discussed in an OBBBA webinar held on July 24, 2025 shortly after the bill went into effect. We will discuss a few of the notable changes below but will focus on the state and local tax (SALT) deduction and its impact on the pass-through entity tax election (PTET).
No Tax on Tips and No Tax on Overtime
These were crucial promises made from President Trump during his campaign trail.
For tax years 2025 through 2028, employees and self-employed individuals may deduct qualified tips, up to $25,000, received in specified occupations, and that are reported on a Form W-2, Form 1099, or other tax form or reported directly by the individual on Form 4137.[2]
Similar to above, individuals who receive qualified overtime compensation may deduct the pay that exceeds their regular rate of pay and that is reported on a Form W-2, Form 1099, or other tax form furnished to the individual.[3] The maximum annual deduction is $12,500 ($25,000 for joint filers).
Both deductions are available for itemizing and non-itemizing taxpayers. These deductions phase out for taxpayers with modified adjusted gross income (MAGI) over $150,000 ($300,000 for joint filers).
State and Local Tax Deduction
Before the TCJA was enacted in 2017, the SALT deduction was uncapped and taxpayers could claim a deduction for any amount (subject to the Pease Limitation[4]). When the TCJA limited the deduction to $10,000 it was a big hit to taxpayers, particularly those in high tax states. Fortunately, the OBBBA has significantly revamped this section of the Internal Revenue Code.
Section 164 was amended to increase the SALT deduction to $40,000 ($20,000 for married filing separate).[5] In 2026, the cap will be $40,400, and will increase by 1% annually from 2027 through 2029. The SALT deduction cap is temporary and is set to return to $10,000 in 2030. For taxpayers whose MAGI is over $500,000 the SALT deduction will be reduced by 30% of the excess (if any) of the taxpayer’s MAGI over the threshold amount.[6] The threshold amount is $500,000 beginning in 2025, $505,000 in 2026, and for tax years after it is 101% of the prior year’s limit.[7]
Impact on the PTET
When the TCJA limited the SALT deduction, many high tax states, including California, came up with a work around for the $10,000 limitation with the creation of the PTET.[8] This is a tax levied on an entity, which must be a partnership or S Corp., under which the passthrough entity elects to pay an entity-level tax in return for a credit or deduction against the state tax ,which reduces the income distributed to the owner of the pass-through entity.[9]
For taxpayers that qualify, the PTET credit and SALT deduction provide excellent tax planning and saving opportunities.
Here are some simplified examples, using California as a reference, of how the PTET credit would work and how it interacts with the SALT deduction.[10] There are strict timing requirements and payment deadlines, but we will focus on the overall mechanics of the PTET credit in the examples below.
Example 1 A partnership sells their vacant, depreciated, office building for $1,000,000. The partners want to cash out and exit. The partners elect to pay the PTET at the entity level, at 9.3%, which is $93,000. On the Schedule K-1, the $93,000 credit would be allocated to each of the partners equally, which assuming there are three partners, is $31,000 each. The credit would reduce their income allocation from $333,333 to $302,333 for each partner. If this is each partner’s only source of income, they would also be able to claim the SALT deduction for their entire California tax liability, producing a total state tax saving of 17.7%.[11]
The partnership can claim a deduction for paying the PTE tax for federal income tax purposes, which would reduce the income reported on the federal K-1 to the partners.
Example 2 a S Corp. engaged in medical services sells their business in an asset sale for $10,000,000. The two shareholders elect to pay the PTET at the entity level which is $930,000. This would reduce each shareholder’s allocable share of income by $465,000 on their K-1 to $4.5 million each. While they get the benefit of the PTET credit, their SALT deduction will be phased out based on their income.
Some Pros and Cons
As the examples illustrate, the PTET election has many benefits particularly in a transactional context, but one drawback is when you have out of state members who are not subject to tax in California. For example, where some shareholders of an S Corp., who are nonresidents, don’t elect to receive the PTET credit, you can’t have special allocations for one shareholder and not for the others.[12] This will risk jeopardizing the S election for the entity.
Currently, the PTET election in several states are set to expire at the end of 2025, but it is anticipated they will extend this. For example, California recently enacted Senate Bill 132 (SB 132) to extend the PTET to 2030.
There are also strict timing and payment requirements that must be adhered too, in addition to eligibility requirements for the entity and shareholder. SB 132 relaxed some of the payment and timing requirements, but the eligibility requirements remains. For example, taxpayers who own their interest through a passive holding company structure will not qualify for the PTET election.[13] This exposes them to higher state and federal taxes, absent any pre-deal restructuring.
Conclusion
The PTET credit is useful since the SALT deduction is phased out for many high-income taxpayers, but it has its limitations. Raising the SALT deduction cap is beneficial for taxpayers overall and is more easily accessible than the PTET credit. This is not as useful as before the TCJA where there was no limit on the SALT deduction, but this is a step in the right direction.
Watch The Webinar | Subscribe for the next installment.
[1] H.R. 1 Public Law 119-21.
[2] IRC § 224; Specified occupations are food and beverage service, barbering and hair care, nail care, and esthetics.
[3] IRC § 225.
[4] IRC § 67.
[5] IRC § 164(h)(7)(A). This will be adjusted for inflation.
[6] For married individuals filing separate, the threshold amount is $250,000 (half the regular threshold).
[7] IRC § 164(h)(7)(B)(ii).
[8] Currently there are 36 states and New York City who provide a PTET credit.
[9] Each state has different rules, but generally the owner must be an individual, fiduciary, estate, trust, or a disregarded entity.
[10] California is our base case, but the other states PTET systems are very similar, albeit with nuances in timing and eligibility.
[11] Assuming a tax rate of 9.3%, their CA tax liability would be $28,117, which can be claimed in full for the SALT deduction.
[12] Treas. Reg. § 1.1361-1(l)(1); Disproportionate Distribution requirement for S Corp. This assumes that the state they reside in does not have a credit for taxes paid to another state where income is earned at the entity level.
[13] Unless the holding company is a single member LLC owned by an individual, fiduciary, estate, or trust.
