Case study: a psychologist’s S corporation and PTE election

This case comes from our own files. A psychologist in solo private practice, with patients in two states, had about $200,000 of profit for 2025, which would have been reported on Schedule C without an election. We made an S corporation election effective for 2025, set the owner’s salary at $130,000, and had the corporation elect to pay state income tax at the entity level in one of the two states, while passing on the same election in the other. The client agreed to this write-up. We have left out the client’s name, location, and practice, and both states, and the figures are the ones our file records. The profit figure is rounded in the file, so every result figured from it below is rounded to the nearest hundred dollars.

Below we figure the payroll tax side of the result from the file under 2025 law. The federal value of the state election depends on figures the file does not hold, and we say which ones rather than estimate them.

Social Security and Medicare tax without the election

As a sole proprietor, the owner would have paid self-employment tax on the practice’s profit. The 2025 Schedule SE applies the tax to 92.35 percent of net profit, which on about $200,000 is about $184,700. The Social Security part, 12.4 percent under section 1401(a), stops at $176,100 of earnings for 2025, so it comes to $21,836.40, the most it can be for 2025. The Medicare part, 2.9 percent of the full amount under section 1401(b), is about $5,400. Together that is about $27,200, and section 164(f) allows half of it, about $13,600, as a deduction.

What the S election changed

With the election, the owner became an employee of the corporation. Publication 15 says that when a business is incorporated, corporate officers who work in the business are employees of the corporation, and the IRS guidance on S corporation compensation says the corporation must pay reasonable compensation to a shareholder-employee before making non-wage distributions. We set the salary at $130,000 from Bureau of Labor Statistics wage data for psychologists, adjusted for the owner’s experience and the work the owner actually does, and wrote the basis up in a memo for the file. Our post on reasonable compensation for therapists describes how we approach that number for a clinician-owner in general.

Publication 15 for 2025 set Social Security tax at 6.2 percent each for the employer and the employee on wages up to $176,100, and Medicare tax at 1.45 percent each with no wage limit. The whole $130,000 salary was under the wage base, so the two shares came to $19,890, or $9,945 each. The corporation deducts the salary on line 7 of Form 1120-S and its own share of the payroll tax with its other business taxes on line 12, which leaves about $60,100 of the profit passing through to the owner on Schedule K-1, on the file’s figures. The Form 1120-S instructions say that S corporation income “isn’t self-employment income and isn’t subject to self-employment tax.”

Social Security and Medicare tax therefore fell from about $27,200 to $19,890, a saving of about $7,300 for 2025 on the file’s figures. The income tax side gives part of that back, because the owner no longer deducts half of a self-employment tax, while the corporation deducts its smaller share of payroll tax instead. At an illustrative 24 percent marginal rate, the cost net of those deductions is about $23,900 without the election and about $17,500 with it, a difference of about $6,400. The file does not record the owner’s marginal rate. We use 24 percent as an assumption, close to the rate implied by the rounded net figures in the file, and at another rate the difference would change with it.

That is the payroll tax part of the comparison, and it is not the whole federal result. The file’s breakdown does not show the qualified business income deduction on either side. Under section 199A(c)(4), reasonable compensation paid to the owner is not qualified business income. Treasury Regulation section 1.199A-5 names psychologists among the providers of services in the field of health, so whether the practice produces the deduction at all depends on the owner’s taxable income. For an owner below the threshold, the election generally makes the deduction smaller, which works against the payroll tax saving, as the worked example in our post on when to elect S corporation status shows. The file also does not record the added cost of payroll processing, unemployment taxes and the corporate returns, which comes out of the saving as well.

How an entity-level election works

An entity-level election, often called a pass-through entity tax or PTE election, has the S corporation pay a state’s income tax on the owner’s share of its income instead of the owner paying it personally. The federal treatment comes from IRS Notice 2020-75. In it the Treasury Department and the IRS announced that they intend to issue proposed regulations, and said taxpayers may rely on the notice until those are issued. Under the notice, income tax a partnership or S corporation pays to a state on its own income is deductible by the entity for the year the payment is made, and is not taken into account in applying the state and local tax limit to its owners. The deduction shows up as lower income on the owner’s Schedule K-1 rather than on the owner’s Schedule A.

Each state that offers the election writes its own rules for it, so the deadline, the rate, and the effect on the owner’s personal return come from that state’s law, and the comparison has to be run separately for each state. In this case the corporation made the election in one of its two states. Our file records that in the other, once that state’s credit rules were run through the federal computation, the election came out about even, so the corporation did not make it there. Running that comparison state by state is part of our multi-state work.

The SALT limit after P.L. 119-21

Before P.L. 119-21, section 164(b)(6) limited an individual’s deduction for state and local income, sales, and property taxes to $10,000 ($5,000 for married filing separately). Section 70120 of the act replaced that figure with an applicable limitation amount defined in a new section 164(b)(7), for tax years beginning after December 31, 2024. The limit is $40,000 for 2025 and $40,400 for 2026, rises 1 percent a year for 2027 through 2029, and returns to $10,000 for tax years beginning after 2029, with half of each amount for married filing separately. Through 2029 it is reduced by 30 percent of modified adjusted gross income above $500,000 for 2025 and $505,000 for 2026, but not below $10,000. The 2025 Schedule A instructions give the married filing separately figures for 2025 as $20,000, a $250,000 threshold, and a $5,000 floor. On that arithmetic the limit reaches the $10,000 floor at modified adjusted gross income of $600,000 for 2025, and at about $606,333 for 2026.

For 2025, then, an owner whose modified adjusted gross income is under $500,000 has a $40,000 limit, four times the old one. An owner who itemizes and whose state and local taxes stay under that limit can deduct the state income tax on Schedule A anyway, so moving the tax to the corporation changes where the deduction is taken more than whether it is taken. The election keeps its federal value where the personal deduction would be lost. That happens when the owner takes the standard deduction instead of itemizing, or when the owner’s state and local taxes are above the limit, as they are more likely to be once modified adjusted gross income passes the threshold. Because the corporation’s deduction lowers the income on the K-1, it also lowers the adjusted gross income the phase-down is measured from. That reduction also generally lowers the qualified business income the section 199A deduction is figured on.

For this client, our file records that before the elections the owner’s state and local taxes ran past the $10,000 limit that applied before P.L. 119-21. Under the $40,000 limit the act set for 2025, the federal value of the corporation’s state tax payment turns on whether the owner’s total state and local taxes exceed that limit after the phase-down for modified adjusted gross income, and on whether the owner itemizes at all. The file does not record the owner’s total state and local taxes, modified adjusted gross income, filing status, or whether the owner itemized, so we do not put a dollar value on the election for 2025. For a practice weighing the same structure, we figure it from that practice’s own numbers before recommending anything.

What the engagement involved

The corporation runs payroll for its owner. Publication 15 lists what that means for the employer, including depositing the withheld income tax and both shares of Social Security and Medicare, generally filing Form 941 each quarter, giving each employee a Form W-2, and filing Copy A with Form W-3. The corporation registered for payroll in each state where the owner performs services. It registered as a foreign corporation in the second of the two states and files a return there, and it tracks revenue by state through the year so the state returns rest on the books rather than on a reconstruction at year end. The salary memo stays in the file. Because Notice 2020-75 ties the federal deduction to the year of payment, a calendar-year corporation that wants the deduction for a year has to pay the state tax by December 31 of that year.

Looking at 2026

For a practice weighing the same elections for 2026, the federal limit is $40,400 and the phase-down threshold is $505,000. The December 31 payment date for the federal deduction still applies, while the deadline for the election itself and any estimated payments come from the state’s own law. The rest of the December list is in our year-end tax planning post.

Where we help

We run this comparison for psychologists and other clinicians as part of tax planning, working out the salary and each state’s election together from the practice’s own numbers. Our S corporation work covers the election and the salary, our post on multi-state filing covers how a second state comes into the picture, and our page for psychologists covers what else is different about a doctoral practice’s return. If you are deciding whether either election makes sense for 2026, book a consultation and we will run your numbers with you.

This post describes one client’s 2025 figures and the rules that apply to them, as general information. It is not advice for any particular practice.

• S corporation
• Elections
• Multi-state