If a partnership elects a pass-through entity tax, does it still withhold for nonresident owners?

Why the two regimes do not collapse into each other

The elective pass-through entity taxes exist for a federal reason. IRC section 164(b)(6) capped the individual deduction for state and local taxes beginning in 2018, and IRS Notice 2020-75 announced that a partnership or S corporation deducts a "Specified Income Tax Payment" in computing its non-separately stated income (section 3.01), and that such a payment "is not taken into account in applying the SALT deduction limitation" to its partners or shareholders (section 3.02(4)). The notice defines the term to include tax imposed directly on the entity "without regard to whether the imposition of and liability for the income tax is the result of an election by the entity," or whether the owners receive a credit or other benefit based on their share of it (section 3.02(1)). The states built their elective taxes on that definition: the entity pays, deducts, and passes a credit to the owners.

Nonresident withholding serves a different purpose. A state cannot easily reach a nonresident owner of an in-state partnership, so it makes the partnership collect at the source and credits the amount to the nonresident at filing; the money is the owner's, held and remitted by the entity. Enacting an elective tax does not by itself alter a withholding statute. Where a state coordinates the two, the coordination takes one of three forms: the election replaces withholding, the election leaves withholding alone, or the election leaves withholding on the books but lets the owner's credit reduce or excuse the payment.

The 2025 federal act changed the cap figures. For 2025 the IRS Schedule A instructions state an overall limit of $40,000 ($20,000 married filing separately), reduced where modified adjusted gross income exceeds $500,000 ($250,000 filing separately) but not below $10,000 ($5,000 filing separately). For 2026 the IRS states a limit of $40,400 ($20,200 filing separately), reduced above $505,000 ($252,500 filing separately), with the same floor. An election's federal value under Notice 2020-75 is therefore concentrated among owners whose state and local taxes exceed their limit, including owners in the phase-down range.

California: the election changes nothing about withholding

California's elective tax was first enacted for taxable years beginning in 2021 through 2025 (Cal. Rev. & Tax. Code section 19902, with the owner credit in section 17052.10). Senate Bill 132 extended it to taxable years beginning on or after January 1, 2026 and before January 1, 2031 by adding Part 10.4.1 of Division 2 of the Revenue and Taxation Code (sections 19910, 19912, 19914 and 19916) and a new credit in section 17052.11. The tax is 9.3 percent of the qualified net income of an electing partnership or S corporation, meaning the distributive shares and guaranteed payments of the consenting owners, who are individuals, fiduciaries, estates and trusts and may be residents, nonresidents or part-year residents. The Franchise Tax Board's guidance limits a nonresident owner's share of qualified net income to income subject to the California personal income tax, determined under the applicable sourcing rules. The election is made on a timely filed original return, cannot be made on an amended return, and is irrevocable for the year once made.

The Franchise Tax Board's answer on withholding is one sentence: "The qualified entities' election does not affect the 7% withholding requirement." The withholding regime under section 18662, covered in the library's article on California pass-through withholding for domestic nonresident owners, continues to require the entity to withhold 7 percent of distributions of California-source income to a domestic nonresident owner once the calendar-year total passes $1,500, unless a Form 590 certification or a Form 588 waiver is in place, with quarterly remittance on Form 592-Q, an annual Form 592-PTE due January 31, and a Form 592-B to each owner withheld upon (FTB Publication 1017). The election adds a second payment stream, and the nonresident owner claims both as credits.

Two consequences follow. The first is cash. An electing entity with a Nevada individual partner pays 9.3 percent of that partner's share of qualified net income as elective tax and, if it distributes, withholds 7 percent of the California-source distribution as well. Together the two can exceed the partner's California liability on that income; the excess withholding comes back only by refund on the partner's return, and unused elective tax credit carries forward for up to five years. The timing is front-loaded: the elective tax requires a June 15 payment during the election year (the greater of $1,000 or half of the prior year's elective tax), and for 2026 and later a missed or short June 15 payment no longer bars the election but reduces each owner's credit by 12.5 percent of the owner's share of the unpaid amount (sections 19914(b) and 17052.11). An entity that treats the election as a substitute and stops remitting faces the withholding-agent liability described in the library's California withholding article. The second is the group return. The FTB permits an electing entity to file a group nonresident return, but the elective tax credit "cannot be claimed on a group return" and is available only on the individual return of the qualified taxpayer. A nonresident owner who wants the credit files an individual return.

New York: the obligation stays, the credit reduces it

New York's pass-through entity tax lives in Tax Law Article 24-A. An eligible partnership, defined in section 860(a) as a partnership with a filing requirement under section 658(c)(1) other than a publicly traded partnership, elects annually under section 861 on or before the due date of the first estimated payment, and the election "is irrevocable after the due date"; the Department states that date as March 15. The tax under section 862 runs on pass-through entity taxable income at graduated rates from 6.85 to 10.90 percent. For a partnership, section 860(h)(1) defines that income by reference to partners subject to tax under Article 22: the New York-source items of nonresident partners, all items of resident partners, and certain pass-through entity taxes paid. Corporate partners are not subject to Article 22, so their shares never enter the base. Direct partners subject to Article 22 take the credit under section 863, "computed pursuant to the provisions of subsection (kkk) of section six hundred six," and the Department states that excess credit is "credited or refunded without interest."

New York's withholding analog is not labeled withholding. Tax Law section 658(c)(4)(A) requires a partnership with nonresident individual or C corporation partners to pay estimated tax on their behalf on their shares of New York-source income at the highest applicable rate, "reduced by the distributive share or pro rata share of any credits determined under section one hundred eighty-seven, one hundred eighty-seven-a, six hundred six or fifteen hundred eleven of this chapter, whichever is applicable, derived from the entity." Section 658(c)(4)(D) excuses the entity where a partner's estimated tax does not exceed $300, where the partner is on an authorized group return, or where the Commissioner has granted a waiver. The paragraph does not mention Article 24-A or electing partnerships, but its credit reduction does the coordinating work: the entity tax credit is a section 606 credit derived from the entity, so it reduces the payment for an individual partner, while a C corporation partner, which receives no such credit, gets no reduction.

The Department's 2026 instructions for Form IT-2658 apply the statute in those terms: if the partnership elected the pass-through entity tax for the current taxable year, "the entity may take the PTET credit into account when computing estimated income tax payments for its nonresident partners, members or shareholders who are nonresident individuals," and the entity "will still be required to make estimated MCTMT payments and estimated tax payments on behalf of corporate partners." For a nonresident individual, the entity computes the payment at the highest rate, subtracts the expected credit, and remits the remainder, which may be zero; the CT-2658 payments for corporate partners continue unchanged.

That design has a failure mode. The reduction rests on a credit the partner has not yet received, and section 863(a)(2) allows no credit unless the electing entity paid the Article 24-A tax, while section 863(b) caps the partners' combined credits at the entity's tax due. An electing partnership that reduces its IT-2658 payments and then underpays its section 864 estimates has reduced one prepayment on the strength of another. Section 658(c)(4)(C) imposes $50 per failure for each partner absent reasonable cause and an addition to tax on an underpayment of the estimated tax required; the partner's own underpayment exposure is the larger consequence. The group return offers no shortcut: the Department states that the credit "may not be claimed on Form IT-203-GR."

New Jersey: excused where the owner expects a refund

New Jersey's Pass-Through Business Alternative Income Tax was enacted by P.L. 2019, c. 320 (N.J.S.A. 54A:12-1 and following) and amended by P.L. 2021, c. 419, effective January 1, 2022. An electing entity pays the tax on its members' distributive proceeds, which for a partnership's nonresident partners the 2021 amendment limits to "the distributive share of partnership income derived from sources inside New Jersey." Each member takes a credit under N.J.S.A. 54A:12-5, and credit in excess of the member's tax "shall be an overpayment for the purposes of N.J.S.54A:9-7 or R.S.54:49-15, as appropriate," which makes it refundable.

New Jersey's withholding analog is the nonresident partner tax under N.J.S.A. 54:10A-15.11, a provision of the Corporation Business Tax Act that requires a partnership to remit a payment on behalf of its nonresident partners, at 6.37 percent for noncorporate and 9 percent for corporate nonresident partners, reported on Form NJ-CBT-1065, with a signed Form NJ-1065E kept on file for certain partner types.

The 2021 amendment coordinated the two regimes expressly. P.L. 2021, c. 419 added to section 54:10A-15.11 the sentence: "A partnership shall not be required to remit a payment of tax pursuant to paragraph (1) of this subsection for any nonresident that reasonably expects to be refunded the payment on account of a tax credit pursuant to section 5 of P.L.2019, c.320 (C.54A:12-5)." The Division's published answers draw the line at the same date: for tax years before 2022 an electing partnership still filed Form NJ-CBT-1065 and remitted for its nonresident partners; beginning in tax year 2022, "a partnership is not required to remit tax on behalf of any nonresident partner who reasonably expects to receive a full refund of that tax based on their share of the BAIT credit." The 2025 Form NJ-1065 instructions apply the rule to noncorporate and corporate partners alike.

The New Jersey test is therefore an expectation test, partner by partner. A nonresident whose only New Jersey item is the partnership share, and whose share of the entity tax covers the liability on it, fits the test. A nonresident with other New Jersey-source income, or whose share of the entity tax falls short, may not, and for that partner the nonresident partner tax remains due in whole or in part.

Illinois: the election replaces withholding, with one carve-out

Illinois substitutes. The pass-through entity tax under 35 ILCS 5/201(p), effective for tax years ending on or after December 31, 2021, is imposed at 4.95 percent of the electing entity's net income, and each partner or shareholder takes a credit at the same rate on the partner's distributive share. Pass-through withholding under 35 ILCS 5/709.5 is the separate obligation to pay on behalf of nonresident members, a group in which the Department counts corporations, S corporations and partnerships, on the business and nonbusiness income they receive from the entity.

The Department of Revenue's Publication 129 (R-12/25) states the relationship directly: "A pass-through entity will pay pass-through withholding or PTE tax, but not both." Pass-through entities must withhold for their nonresident members "unless the pass-through entity is a partnership or S corporation who elects to pay PTE tax for all their members," and any Form IL-1000-E on file can then be ignored. The one carve-out is the investment partnership: for tax years ending on or after December 31, 2023, an investment partnership withholds on its applicable nonresident partners, and "Electing to pay PTE tax does not exempt an investment partnership from withholding for its nonresident partners."

Public Act 104-0468 gives an electing partnership a choice of two bases for tax years ending on or after December 31, 2026: the Illinois-source portion of all partners' distributive shares, or resident partners' full distributive shares plus nonresident partners' Illinois-source income (Department bulletin FY 2027-01, July 2026). The bulletin describes no change to the substitution rule. The trap runs in the opposite direction from California's: Publication 129 allows members credit only for their share of the PTE tax "to the extent that the PTE tax was paid," so an electing entity that underpays has left its nonresidents with neither withholding nor full credit.

The pattern, and where the open questions sit

Lined up, the four states show three models. Illinois substitutes: elect for all members and the withholding obligation goes away, except for investment partnerships. California stacks: elect and the withholding continues untouched, with both amounts credited on the owner's return. New York and New Jersey offset: the obligation stays in the statute, and the owner's credit reduces it (New York, through the statutory credit reduction the Department's instructions apply) or excuses it (New Jersey, where the owner reasonably expects a full refund). The library's article on Ohio pass-through entity withholding describes a further variant, a choice among a withholding return, a composite return and the electing entity return in which the first return filed fixes the regime for the year.

Two questions recur regardless of model. The first is who is in the entity tax base and who is in the withholding population, because they are rarely the same set. California's elective tax covers consenting individual, fiduciary, estate and trust owners, while its withholding reaches nonresident corporations and pass-through owners as well; New York's tax covers Article 22 partners and leaves corporate partners to section 658(c)(4); Illinois's election runs to every member, which is why it can substitute. For an owner outside the entity tax base, the withholding question is answered as if no election had been made. The second is the group return, which treats the credit differently by state: California and New York keep the entity tax credit off the group return, while New Jersey's composite return carries a line for it. An owner who files no return, or joins a group return that cannot carry the credit, leaves the entity's payments with the state.

The open questions are administrative. New York's reduction depends on a credit that exists only if the entity pays, and the IT-2658 computation is made before the entity's own tax is final. New Jersey's expectation test is applied by the partnership at filing time without a published standard for what makes an expectation reasonable. California's guidance is one FAQ sentence, and the Franchise Tax Board's domestic withholding rulemaking, still in the regulatory process and discussed in the library's California withholding article, would change the overlap if adopted.

Practice notes

The election and withholding analyses are run together, state by state, before the first payment date, because New York's election closes on March 15 and California's June 15 payment can arrive before the owner census is settled. For each state the file holds both statutes and the agency's published statement on how they interact, with the form year noted, and one owner census serves both regimes. In California the Form 592-Q and Form 592-PTE calendar continues unchanged, and the elective tax and the withholding are tracked as two accounts. In New York the IT-2658 computation for each nonresident individual partner shows the gross payment, the credit reduction and the remainder, the entity's own section 864 estimates are tracked against the credit assumed, and the CT-2658 payments for corporate partners continue in full. In New Jersey the file records, partner by partner, why a nonresident was or was not excused under N.J.S.A. 54:10A-15.11. In Illinois the election is confirmed as covering all members, the investment partnership carve-out is checked, the 2026 base choice is documented on the IL-1065, and the entity's quarterly estimates are tracked as the payments on which the nonresidents' credit depends. G&G State Tax Group provides multistate pass-through entity tax election and nonresident withholding coordination alongside its state and local tax practice.