The Connecticut Pass-Through Entity Tax Is Still Doing Its Job — But the Compliance Calculus Is Getting Harder

My grandfather, an IRS trial attorney in the late 1960s and 1970s, used to say that tax law is stable only to the extent that Congress is distracted. I think about that line whenever I write about the Connecticut Pass-Through Entity Tax. The PET, enacted in 2018 as Public Act 18-49 and codified at Conn. Gen. Stat. § 12-699 et seq., was Connecticut's direct response to the TCJA's $10,000 cap on the federal deduction for state and local taxes. Seven years later, it remains the cleanest of the state-level SALT cap workarounds — but the interaction with recent IRS guidance, the 2023 Connecticut amendments converting the PET from mandatory to elective, and the pending sunset of TCJA provisions are all pressing on what was, briefly, a simple answer to a complicated problem.

The original structure, briefly

The original 2018 PET worked by shifting Connecticut income tax liability from the individual partners or S-corporation shareholders of pass-through entities onto the entity itself. The entity paid Connecticut tax at a rate roughly equivalent to what the individual owners would have paid, the owners received a credit for their share of the entity-level tax against their individual Connecticut liability, and the entity deducted the tax as an ordinary and necessary business expense on its federal return — a deduction that was not subject to the $10,000 SALT cap because it was entity-level rather than individual-level.

IRS Notice 2020-75 blessed this structure in late 2020, confirming that state-level pass-through entity taxes are deductible at the entity level for federal purposes regardless of whether the state's version of the tax is mandatory, elective, or structurally similar. That guidance caused a wave of other states to enact their own versions — by late 2023 more than thirty states had adopted some form of pass-through entity tax, each with its own quirks and election procedures.

The 2023 Connecticut conversion to elective

The 2023 amendment to the Connecticut PET — Public Act 23-204, taking effect for tax years beginning January 1, 2024 — converted the Connecticut PET from mandatory to elective. Under the original 2018 framework, virtually all Connecticut pass-through entities were required to pay the PET (with a handful of exceptions); under the 2023 amendment, the entity elects annually whether to be subject to the PET.

The conversion solved a real problem. Under the mandatory regime, many pass-through entities were paying Connecticut tax at the entity level even when the federal deduction benefit was negligible or negative — for example, entities with significant out-of-state owners who could not efficiently use the Connecticut credit against their individual state liability. The elective regime lets the entity optimize based on its specific owner composition.

It also created a real compliance burden. The election is not a one-time decision — it is made annually, by the entity, typically by the original due date of the entity's Connecticut return. For a multi-owner entity, the election requires coordination among the owners, because the election affects their individual filings. The DRS has published guidance in TSSB-2023(7) and subsequent bulletins clarifying election mechanics, but the coordination problem is still real in practice.

Where we are seeing compliance friction

Three patterns of friction in the last two tax seasons.

Owner-level coordination on the election. Pass-through entities with multiple owners across multiple states need to coordinate on whether to make the Connecticut PET election, because the election affects the Connecticut credit available to the Connecticut-resident owners and, in some cases, affects the owners' ability to claim credit in their home states for taxes paid to Connecticut. We have had two engagements in the last twelve months where the election was made without owner coordination, producing unexpected tax results for one or more owners and, in one case, requiring an amended entity-level return to withdraw the election.

Estimated-payment mechanics. The elective regime has complicated the estimated-payment structure. Under the mandatory regime, estimated payments were required on a predictable quarterly basis. Under the elective regime, the entity does not know for certain whether it will be subject to the PET until the election is made — but the estimated-payment deadlines do not wait for the election. The DRS has offered some flexibility on this, but the interaction between the election timing and the estimated-payment obligations produces real cash-flow and planning issues, particularly for entities on the margin of electing.

Multistate consistency. For pass-through entities with operations or owners in multiple SALT-cap-workaround states, the multistate compliance calculus has gotten genuinely complicated. Each state's PET regime has its own election procedures, rates, credit mechanics, and interaction with the federal framework. A Connecticut LLC with owners in New York, Massachusetts, and California is now facing four separate state-level pass-through tax regimes, each with its own election decision, each affecting the federal deductibility of the entity-level tax differently. The administrative cost of optimizing across all four is meaningful, and in some cases the optimization saves less than the cost of figuring it out.

What the TCJA sunset changes

The TCJA's $10,000 SALT cap is itself scheduled to sunset on January 1, 2026 — along with the rest of the TCJA individual provisions. If the cap sunsets and is not extended, the underlying rationale for the PET regime largely disappears: individual owners would again be able to deduct state and local taxes on their federal returns without a cap, and the entity-level pass-through tax structure becomes an administrative cost with no corresponding federal benefit.

Three possible paths:

The cap is extended. If Congress extends the $10,000 cap (or modifies it to a higher cap), the PET regimes continue to be useful. This is probably the most likely outcome, though the form and timing of the extension are both uncertain.
The cap sunsets without replacement. If the cap sunsets and is not replaced, the Connecticut PET will likely be repealed or substantially modified, because the administrative burden of maintaining the regime would exceed the shrinking benefit. The 2023 conversion to elective makes a clean repeal easier politically — there would be no forced return to a pre-PET regime for entities that had not elected in any event.
A middle path. Congress adopts a higher cap (e.g., $40,000 or a cap scaled to income) that partially restores the SALT deduction without eliminating it. In that case, PET regimes would continue to be useful for higher-income taxpayers but less so for the middle of the market.

For Connecticut pass-through entities planning their 2025 and 2026 elections, the planning horizon is genuinely short. The 2025 election decision must be made without knowing what the 2026 federal framework will look like; the 2026 election, made in the first quarter of 2026, will be made shortly after whatever legislative action happens (or does not happen) on the TCJA extenders.

Practical guidance for the current filing season

For Connecticut pass-through entities filing their 2024 returns in the current season, and making their 2025 elections:

Coordinate among owners before the election. A written record of the election decision and the owner coordination, kept with the entity's tax files, will avoid disputes if any owner's individual filing produces an unexpected result.
Plan estimated payments around the election assumption. If the entity is electing for 2025, estimated payments should be structured on that assumption from the first quarter. If the election is uncertain, build in a buffer.
Review the credit mechanics for out-of-state owners. Connecticut-resident owners receive a full credit for their share of the Connecticut PET against their individual liability. Out-of-state owners may or may not receive credit in their home state; the answer varies by state and by tax year. This is worth checking annually rather than assuming last year's answer.
Track the federal legislative picture. Any pass-through entity large enough to be meaningfully affected by the Connecticut PET is large enough to have tax counsel monitoring the federal TCJA extenders discussion. The 2025 and early 2026 legislative calendar will matter here.

My colleague Wally Reynolds handles much of our partnership-audit and state-tax-controversy work, and has written separately about the IRS's use of the Bipartisan Budget Act partnership audit procedures. For Connecticut pass-through entities evaluating their PET election, estimated-payment mechanics, or multistate coordination, the Tax group is available.