Introduction: Pass-Through Entity Tax Looks Different From London
A pass-through entity tax is a state income tax that a US partnership or S corporation elects to pay itself, so that its owners escape the federal cap on state tax deductions. In America, it is the most popular tax election of the decade. Around 36 states now offer one. For a partner living in New York or California, the saving is real and simple.
For a partner living in Britain, however, the arithmetic changes. You pay UK tax on the same profit at up to 45%. HMRC then gives credit for the US tax you suffered. Therefore, every dollar the election saves in Washington can reappear as a dollar owed in London. In some structures the result is worse, because HMRC may refuse credit for a tax the entity paid.
No American guide covers this. They are written for owners who live in one country. At TaxYork, we prepare US and UK returns for partners, founders and investors with a foot in each system. This guide explains how the election works in 2026, when it survives the journey across the Atlantic and when it does not.
What Pass-Through Entity Tax Is and Why It Exists
Pass-through entity tax in one paragraph
A pass-through entity tax, often shortened to PTET, moves state income tax from the owner to the business. Normally a partnership pays no income tax. Its profit passes to the partners, and each partner pays state tax personally. Under the pass-through entity tax election, the partnership pays the state tax on that profit instead. The partner then receives a state credit, so the state collects roughly the same amount. The difference lies entirely in the federal deduction.
The SALT cap after the 2025 legislation
Since 2018, individuals have faced a cap on the federal deduction for state and local taxes under section 164 of the Internal Revenue Code. The cap was $10,000 for seven years. The 2025 legislation raised it to $40,000, and it stands at $40,400 for 2026. However, the higher figure shrinks for high earners. Above modified adjusted gross income of about $505,000, it falls by 30 cents for each extra dollar until it returns to $10,000.
Consequently, the people we work with gained almost nothing from the increase. A partner earning $1 million still deducts only $10,000 of state tax personally. Moreover, the whole cap is due to revert to $10,000 in 2030. The IRS summarises the personal rules under deductible taxes.
Notice 2020-75 and why the workaround is safe
A business faces no such cap. In Notice 2020-75, the IRS confirmed that state income tax paid by a partnership or S corporation is deductible in computing the entity's income. The deduction reduces the profit reported to each owner on Schedule K-1. It never touches the owner's itemised deductions, so the cap never applies.
Early drafts of the 2025 legislation would have blocked this for professional firms. Nevertheless, the final law left the workaround untouched. Therefore, the pass-through entity tax election remains fully available for 2026 to law firms, funds, consultancies and trading businesses alike.
How the Election Works in the States That Matter
New York
New York offers its pass-through entity tax to partnerships and S corporations, and New York City adds its own version for city residents. The state publishes the rules on its pass-through entity tax page. The entity must opt in online by 15 March of the year concerned. After the first estimated payment date, the choice is irrevocable for that year. Estimated payments then fall due in March, June, September and December.
The tax covers all the income of resident partners but only the New York source income of non-resident partners. A London partner in a New York firm therefore sits in the non-resident pool. Notably, the firm decides. An individual partner cannot step outside the firm's election, and that matters greatly for a partner who lives in Britain.
California
California charges its elective pass-through entity tax at 9.3%. The Franchise Tax Board explains the regime on its pass-through entity elective tax page. The legislature has extended it through 2030. From 2026, a missed 15 June prepayment no longer cancels the election. Instead, it reduces the owner's credit by 12.5% of the unpaid share.
Two features differ from New York. First, the credit is not refundable, although unused credit carries forward for five years. Second, each owner consents separately. Accordingly, a partner in Britain can decline while the Californian partners accept. That flexibility is valuable, as the case study below shows.
Other states
Illinois, New Jersey, Connecticut, Massachusetts, Virginia and Georgia all run their own version of the pass-through entity tax. Rates, deadlines and credit rules vary widely. Some credits are refundable and some are not. Some states tax the entity at the top personal rate and others at a flat rate. Therefore, a firm with offices in several states must model each election separately.
Composite returns are not the same thing
Many firms already file composite or group state returns for partners abroad. Under that system, the firm pays your state tax on your behalf. However, the tax remains yours. It counts as your own state tax, and the personal cap applies. Only a true pass-through entity tax shifts the liability to the entity and moves the deduction above the line.
How Pass-Through Entity Tax Reaches a Partner in Britain
American citizens resident in the UK
A US citizen in London files a full US return and reports the whole K-1. The profit from the US business is US-source income. Consequently, America taxes it first, and no foreign tax credit applies on the US side. The pass-through entity tax reduces the K-1 profit, so federal tax falls. So far, the American guides are right.
British partners who are non-resident aliens
A British partner with no US status is taxed only on income effectively connected with the US business. We explain that concept in our guide to effectively connected income. The partner files Form 1040-NR and pays graduated rates up to 37%. The partnership also withholds tax on that share under the partnership withholding rules. Here too, the pass-through entity tax shrinks the taxable share and the federal bill.
The UK charge on the same profit
Britain taxes its residents on worldwide income. A UK resident partner therefore pays income tax at up to 45% on the same profit share. To prevent double taxation, HMRC allows foreign tax credit relief for US tax on that income. The credit cannot exceed the UK tax on the same profit. HMRC also accepts most US state income taxes as creditable, and its manual lists the admissible state taxes.
This is where the pass-through entity tax meets the UK system. Your final bill is the higher of the US total and the UK total. If the UK charge is higher, any cut in US tax simply raises the UK top-up by the same amount.
The HMRC Clawback: Why the Saving Can Vanish
The higher rate always wins
Consider the marginal rates first. A top-rate partner pays 37% federal tax. New York adds up to 10.9%, and most of that was not deductible before the election. The combined marginal rate is therefore close to 48%. With the election, the federal deduction brings it down to roughly 44%.
Britain charges 45%. Accordingly, only the slice of saving above 45% is real. Below that line, HMRC collects the difference. Moreover, your average US rate is lower than your marginal rate, because the first bands of income are taxed at less than 37%. Many partners are therefore already under 45% before any election, especially in a lower-tax state such as Illinois. For them, the pass-through entity tax saves nothing at all once the UK return is filed.
Limited partnership or LLC: the structure decides the credit
The second risk is more serious. HMRC gives credit for tax on your income. It classifies each foreign entity as transparent or opaque under its entity classification guidance. A US limited partnership or LLP is normally transparent. Its profits are yours as they arise, and tax charged on those profits should be creditable against your UK tax, whoever physically paid it.
A US LLC is different. HMRC's general view is that an LLC is opaque, so a member is taxed on distributions as if they were dividends. The Supreme Court decided otherwise for one taxpayer in Anson v HMRC. However, HMRC's published response treats that case as turning on its own facts. Where the LLC is opaque, tax paid by the entity is underlying tax. An individual cannot credit underlying tax. Therefore, a pass-through entity tax that converts your personal state tax into an entity tax can destroy a UK credit you used to receive.
Proving the credit to HMRC
Even for a transparent partnership, the pass-through entity tax changes the paperwork. Before the election, you held a state return in your own name. Afterwards, you hold a K-1 and a state credit statement. HMRC is entitled to ask what tax was paid on your share. In our experience, a clear schedule that traces the entity payment to your profit share settles the point. Without it, an enquiry can drag on for a year.
When the Election Still Pays From Britain
High-tax states
Where the combined US rate stays above 45% even after the election, the whole federal saving is kept. That can happen for a California source share taxed at the top state rates. It also happens for a partner with heavy New York City exposure. In those cases, the pass-through entity tax reduces excess US tax that HMRC would never have relieved anyway.
Partners inside the UK's four-year regime
A partner who has recently arrived in Britain after ten years abroad may claim the four-year foreign income and gains regime. While the claim runs, qualifying foreign income escapes UK tax. Whether a share of US trading profit qualifies depends on where the trade is carried on, so the point needs checking. Where it does qualify, no UK charge exists to claw the saving back, and the pass-through entity tax works exactly as it does for an American resident.
Britons living in America
A British executive or founder who lives in the United States usually owes no UK tax on US business profit. For that person, the pass-through entity tax is straightforward. The federal saving is 37 cents for every dollar of state tax shifted to the entity. The 20% qualified business income deduction is slightly reduced, because the entity deduction lowers qualifying income, but the net result is still clearly positive. Our guide to the section 199A deduction explains that interaction.
Partners already in excess credit
Some partners carry US tax that already exceeds their UK liability every year, often because of state tax on several offices. For them, each dollar of federal saving is a dollar kept. Therefore, the first step is always the same. Compare your total US rate with your UK rate on the same profit, before and after the election.
What the Firm Should Do for Its Overseas Partners
Model the partner, not just the firm
Firms decide on the pass-through entity tax by adding up the federal saving across the partnership. That sum ignores partners abroad. A firm with a London office should therefore run a second calculation for each UK resident partner. Our guide for American law firm partners in London sets out the wider return position.
Use special allocations where the agreement allows
Some partnership agreements let the firm allocate the pass-through entity tax expense to the partners whose income generated it. Others equalise it across everyone. For a partner in Britain, the allocation decides how much US tax is replaced and how much UK credit is at stake. Accordingly, read the tax distribution clause before the March election date, not after.
Watch the estimated payments
After a pass-through entity tax election, the entity makes the state payments. A partner who keeps paying personal estimates will overpay. Conversely, a partner who stops federal estimates too early may underpay, because the K-1 saving arrives only at year end. In addition, the UK payments on account are based on the previous year. A rising UK top-up therefore feeds into next July's payment.
Case Study: A Dual National Partner in a New York Firm
The following example is illustrative and uses rounded figures. Daniel is a dual US-UK national and an equity partner in a New York law firm. He lives and works in London and is UK resident. The firm is an LLP, which HMRC treats as transparent. His share of New York source profit for 2026 is $1,000,000. New York tax on that share is $100,000.
Without the election, Daniel pays the $100,000 on a non-resident state return. He deducts only $10,000 of it federally, because his income is far above the phase-down. His federal tax on that share is about $322,000. His total US tax is therefore about $422,000, or 42.2%. Britain charges 45%, which is $450,000. HMRC credits the $422,000, and he pays a UK top-up of $28,000. His worldwide bill is $450,000.
The firm then makes the pass-through entity tax election. The entity pays the $100,000. Daniel's K-1 falls to $900,000, and his federal tax drops to about $289,000. That is a US saving of $33,000. His total US tax is now $389,000. However, the UK charge is still $450,000. HMRC credits $389,000, and his top-up rises to $61,000. His worldwide bill is $450,000, exactly as before. The whole saving has moved from Washington to London.
Now change one fact. Suppose the firm were an LLC and HMRC treated it as opaque. The $100,000 entity tax would then be underlying tax with no UK credit. On the same simplified numbers, Daniel's worldwide cost would rise by up to $100,000. For that reason, we documented the LLP's transparent status in his UK return and attached a schedule tracing the entity payment to his share. His Californian colleague in the same London office, by contrast, declined that state's election for her own share, because consent there is personal.
How TaxYork Can Help
TaxYork provides comprehensive US and UK tax return preparation for partners and owners of US businesses who live in Britain. We prepare the federal return, the non-resident state returns and the UK Self Assessment return together. Specifically, we reconcile the K-1, the state credit statement and the UK foreign tax credit claim, so that every dollar of US tax is relieved once and only once.
Before each election date, we model your personal position with and without the pass-through entity tax. We also review how HMRC will classify your entity. In addition, our cross-border planning service covers the estimated payments on both sides, and our US tax return service handles the annual filings.
Conclusion
The pass-through entity tax is an excellent election for owners who live in America. For partners in Britain, it is a calculation, not a reflex. The saving is federal, yet your final bill is set by whichever country charges more. Where the UK rate is higher, HMRC absorbs the saving. Where the entity is opaque, the election can cost you a credit. Nevertheless, in high-tax states, during the four-year regime and for Britons resident in America, the election still pays in full. Above all, run the numbers for yourself before your firm runs them for everyone.
Contact Us
If your firm is weighing a pass-through entity tax election, or has already made one, ask us to model your position before the next deadline. You can contact us for a confidential review of your US and UK returns. Email hello@taxyork.com or call 020 3488 8606.
Disclaimer
This article provides general information only and reflects US and UK rules as understood in October 2026. It is not tax or legal advice for your circumstances. State election rules, rates and deadlines change frequently, and the UK treatment of a US entity and of tax paid by it depends on the facts. The case study is illustrative and uses simplified figures. Always obtain professional guidance from a qualified specialist before you act. TaxYork accepts no liability for action taken in reliance on this article.