Connecticut's 87.5% Pass-Through Tax Credit Cap: What It Really Costs Your Business,

Running a business in Connecticut already comes with plenty of financial decisions.  Many owners are facing the challenge of the state’s limit on Connecticut’s 87.5% pass-through tax credit cap. The CT pass through entity tax was created to give relief to partnerships, LLCs, and S corporations by letting the business pay state tax on behalf of its owners.  In return, owners would receive a personal CT tax credit for the amount paid.  But since 2019, the state has reduced that benefit. Instead of a full refund, only 87.5% of the payment counts as a credit on the personal return. For a business, this creates a real cost.  The remaining 12.5% of the money is gone.  If you own an LLC or pay the CT S corp tax, this gap can cause thousands of dollars lost each year.  Understanding how the CT pass through entity tax credit works under this cap is the first step to protecting your bottom line.

A. What Is the Pass-Through Entity Tax (PTET)?

Connecticut created the PTET as a way to give business owners a break on federal taxes. Since the business pays the tax at the state level, the owner can often deduct the full amount on their federal return.  In return, the state gives the owner a CT pass through entity tax credit against their personal income tax bill. This mean businesses and their owners are not paying more than they should. But because of CT’s 87.5% tax, owners now only get credit for part of the payment, not all of it. That gap is where the real cost shows up.

B. Breaking down the 87.5% Credit Limit

When Connecticut first introduced the CT entity tax, business owners expected to get full relief on their personal tax returns. That meant every dollar of tax the business paid would translate into a full dollar of credit for the owner. But under the current rule, the credit is capped at 87.5%. For every dollar of PTET paid, the owner only receives 87.5 cents as a CT tax credit on their state return.  The missing 12.5% is not refunded and cannot be carried forward. Consider it as a built-in cost. If your business pays $100,000 in PTET, the owner only gets $87,500 back as a credit. The remaining $12,500 is gone.  For an S Corp in Connecticut, that difference can quickly add up to thousands of dollars each year. This credit cap changes the complete stats for pass-through entities.  Instead of being a full workaround, it leaves business owners with a hidden expense that needs to be planned for carefully.

C. What the 12.5% Gap Really Costs Your Business

Initially the Connecticut pass through tax may look like a fair trade.  You pay the tax at the business level and, in return, claim a credit on your personal return. But the 87.5% cap changes the calculations in ways that are easily missed. That missing 12.5% is not just a technical rule in the law.  It shows up as a real cost that affects cash flow, profits, and long-term planning.  To see the full picture, let’s break it down into 3 parts: hidden tax, the impact on cash flow and profitability, and the discrepancy in state and federal benefits.

1. The Hidden 12.5% Tax

When a business pays the CT pass through entity tax, owners expect to see the full amount credited on their state return. The cap changes this.  Only 87.5% of the tax comes back as a credit and the remaining 12.5% is gone forever. This piece is not refundable and cannot be claimed later.  It works like an extra tax that many owners do not plan for. The number may look small, but it grows with income.  A firm earning several thousand dollars could see hundreds or even more dollars lost each year. This silent cost is why planning is important.

2. Impact on Cash Flow and Profitability

The 12.5% loss does more than raise the tax bill. It directly affects how much cash the business keeps.  Owners often plan their budgets expecting full credit, only to realize later that less money is available. Cash flow is the most important process of any firm. Even a small shortfall can delay payments, slow hiring, or reduce investment in growth.  Eventually, the cap will also lower net profit. What looks like a bookkeeping detail ends up changing how relaxed your business feels every month.

3. Discrepancy in State and Federal Benefits

One of the most confusing parts of the CT pass through tax is the mismatch between state and federal rules.  On the federal side, the full PTET payment is usually deductible, giving owners a real benefit. But at the state level, the credit is capped at 87.5%. This means a business pays tax expecting relief in two places, still gets a partial value in one.  The result is a gap between what owners think they save and what actually shows up on their return. That gap is the actual cost hidden in the system.

D. How to Navigate the Cap: 7 Strategies for Your Business

If you own a pass-through business in Connecticut, you’ve probably heard about the 87.5% tax credit cap.  On paper, it looks like a minor technical rule. But the truth is your 12.5% of money is no more, but you can manage the things out.  The difference lies in whether you plan early or wait for April to find out the damage.  Here are some ways to stay ahead of it:

1. Do a mid year check-in  

Most business owners don’t run numbers until Spring is here, which is a huge mistake.  Think about it in this way: if your company pays $100,000 in pass-through entity tax, the state only credits you $87,500. That leaves $12,500 behind.  If you spot that in July instead of March, you have time to make moves, whether that’s adjusting expenses, planning cash reserves, or shifting how much you take out of the business.

2. Treat the 12.5% like it’s gone

The fastest way to get in trouble is to forget about the missing 12.5%.  That’s money you’ll never get back. If you don’t plan for it, you’ll feel the pinch when payroll hits or when a vendor needs to be paid.  Many businesses set aside that money upfront, and they hardly notice it later.  The ones that ignore it often overcome this small loss. It’s a small shift in mindset, but it makes a big difference.

3. Get professional advice  

The rules for the CT pass-through entity tax can be confusing. While Connecticut cuts your credit, the IRS often allows you to deduct the full amount on your federal return.  A tax professional can help you line up both sides so you don’t miss out on benefits.

4. Rethink estimated payments  

Quarterly payments can be tricky under the cap. Paying too much ties up cash you won’t get back.  Paying too little risks penalties. Running projections during the year with the 87.5% cap in mind keeps your payments accurate.

5. Align business and personal planning  

The CT pass-through entity tax credit shows up on your personal tax return.  That means it can affect your household finances too. If you count on refunds or a certain cash cushion, the 12.5% gap may reduce it.  Planning business and personal taxes together avoids future problems.

6. Think for long term finances

One year of giving up 12.5% may not seem large, but over time it feels like a burden. A business paying $250,000 in PTET loses over $30,000 each year. In five years, that’s more than $150,000, this money could have gone to growth or savings.  You need to plan all your things in advance or consult with your tax advisory consultant  Don’t ignore the cap, this affects your cash flow and profits. Planning for it keeps you in control. The Connecticut pass-through entity tax credit cap may cut into your return, but it does not have to hurt your business.  Build it into your numbers, review your plans during the year, and get help when required. This way, the cap is a cost deduction that you can manage easily and reduce the stress and anxiety during the tax season.

‍

Conclusion

The 87.5% pass-through tax credit cap directly affects your business finances.  The 12.5% doesn’t count as a credit reduces the cash you can use for hiring, equipment, or daily operations. It is seen that businesses who plan for this shortfall do not face any surprise, whereas those who take the tax credit lightly must face repercussions later. The law is unlikely to change soon, so treating the cap as a regular business cost is the safest approach.  By monitoring your numbers, adjusting payments, and seeking professional guidance, you keep control over your cash flow and protect your bottom line. Tax advisory firms like Atheneum help you manage the CT pass-through entity tax cap and optimize your business finances. Schedule a consultation today.

FAQs

1. Who is affected by Connecticut's PTET and the 87.5% tax credit cap?

Owners of S corporations, LLCs, and partnerships in Connecticut are the ones affected. If you elect to pay the state’s pass through entity tax, only part of it counts back as credit on your personal return.

2. Why is the credit capped at 87.5% instead of the full amount?

It’s written into Connecticut tax law. In practice, this means for every dollar of PTET you pay, only 87.5 cents reduces your state income tax bill. The leftover 12.5% doesn’t come back to you.

3. How expensive CT’s 12.5% gap get?

The numbers grow quickly. A business with a $50,000 PTET bill loses about $6,250 to the cap. At $100,000, the “lost” portion doubles to $12,500. It’s money you can’t recover and it eats into profit.

4. What is the difference between a pass through entity and a C-corporation in state taxes?                                                                                                       

Pass-through entities report profits on owners’ personal returns, while C-corporations pay state tax at the company level. Only pass-through entities can use the CT pass-through entity tax credit.

5. How does this credit cap impact my personal tax return?

The 87.5% cap limits how much of the CT pass-through entity tax you can claim. The remaining portion doesn’t reduce personal state taxes, so owners may owe more than expected without planning.

‍