The focus of lawsuits and much congressional attention, the state and local tax deduction, known as the SALT deduction, and the creation of a $10,000 cap on the deduction in 2017 have both practical ramifications for taxpayers and larger ideological consequences.
The SALT deduction gets at the heart of taxation in the U.S., as it attempts to address wide gaps in the levels of taxation from state to state and because it comes at a time when the taxation of the wealthiest Americans has been the center of numerous tax law reform proposals and debates.
State and local taxes vary widely throughout the country — and, subsequently, SALT deductions have been historically highest in high-tax states. For example, the average SALT deduction claimed in New York was $23,804 in 2017 and $5,451 in Alaska in the same year, according to Internal Revenue Service data. The existence of the SALT deduction and its cap most affect high-income taxpayers, taxpayers living in high-tax states, business owners, and taxpayers who opt to itemize deductions.
While a report from the Rockefeller Institute in New York notes the “outsized role New York has in supporting federal spending programs, nationally, and the relatively small amount that returns through social programs, contracts, and wages,” others argue SALT deductions provide an unfair advantage to high-tax states.
Meanwhile, the reduction of SALT deductions may be playing a role in where individuals choose to live, as an increased tax burden resulting from the cap on SALT deductions combines with the rise of remote working opportunities amid the coronavirus pandemic.
“You’re not leveling the playing field for a taxpayer,” says Preston Brashers, senior policy analyst for tax policy at the Heritage Foundation’s Grover M. Hermann Center for the Federal Budget. “You’re giving the advantage to one over the other. If there is a natural migration away from high tax states, that’s not something for the federal government to work out. I see tax competition as a good thing,” Brashers says, because it encourages states to keep taxes low to prevent residents from leaving.
[Read: The Pros and Cons of Standard vs. Itemized Tax Deductions]
What Is the SALT Deduction?
Only taxpayers who itemize their deductions have the opportunity to take the state and local tax deduction, which can reduce their federal income tax liability by deducting certain taxes paid to their state and local government.
The SALT deduction applies to property, sales, or income taxes already paid to state and local governments.
Before the creation of a cap on this deduction, 91% of the benefit of the SALT deduction was claimed by taxpayers with incomes of more than $100,000 and was concentrated in six states: California, Illinois, New Jersey, New York, Pennsylvania and Texas, according to the Joint Committee on Taxation.
[Read: Understanding Federal vs. State vs. Local Taxes]
This Year’s SALT Deduction Cap
Prior to the 2018 tax year, taxpayers could deduct an unlimited amount of state and local taxes on their federal returns. The Tax Cuts and Jobs Act of 2017, however, established a limit to the amount of state and local taxes taxpayers can deduct — likely causing many taxpayers to experience a higher tax liability.
“It used to be that you could deduct those taxes so you weren’t paying twice,” says Lance Rothenberg, director of tax controversy services at CohnReznick in New York. “Then they imposed a cap, and many people around the country, certainly in high tax states, pay much more than $10,000, so in the blue states like New York, New Jersey, California, there was a huge uproar because suddenly they’re having these higher tax burdens.”
In tax years 2018 to 2025, the SALT deduction is capped at $10,000 for single taxpayers, $10,000 for married couples filing jointly and $5,000 for married taxpayers filing separately.
This measure, combined with the near doubling of the standard deduction, will likely greatly reduce the use of the SALT deduction in the years a cap is in effect, according to the Congressional Research Service.
State Workarounds for the SALT Deduction Cap
Since the introduction of a cap to the SALT deduction, some states created workarounds in an effort to help taxpayers who previously took advantage of the SALT deduction avoid a sudden increase in their tax liabilities.
In many states, these workarounds, often called a pass-through entity tax, take advantage of the exclusion of entities in the creation of the deduction cap. Instead of paying tax as an individual, by paying taxes as an entity, these entities are able to avoid the $10,000 cap on SALT deductions.
“An entity can opt into this tax, pay the tax, then the owners essentially get a credit for the tax the entity paid, so there’s no double tax,” Rothenberg says. “Now, this becomes a workaround where at least some segment of the population that would have had a $10,000 cap is no longer subject to the cap.”
[Major State Tax Changes You Might Have Missed]
How to Calculate the State and Local Tax Deduction
Only certain state and local taxes can be deducted on a federal income tax return. Taxpayers can deduct income and property taxes paid to states or deduct their sales tax in place of their income tax, but they cannot deduct both their income and sales taxes.
Before claiming this deduction, experts suggest working with a tax professional to determine which taxes specific to your state and locality are eligible. Gasoline and car inspection fees, for example, cannot be deducted.
Professional tax help with the SALT deduction is also particularly useful as changes to how the SALT deduction is calculated and its limit may be ahead. The current 2017 law changes are set to expire in 2026.
“People make decisions in the margins,” Brashers says. “From my standpoint, we are going to have this debate over the next few years. The cap is set to expire, so this is going to be back on the table.”
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State and Local Taxes: What Is the SALT Deduction? originally appeared on usnews.com
