State and local taxes you pay are deductible if you itemize on your federal income tax return. But the Tax Cuts and Jobs Act of 2017 capped the state and local tax (SALT) deduction at $10,000 for tax years 2018 through 2025.
Because state and local taxes vary widely throughout the country, this cap affects wealthy taxpayers in states with high tax rates the most. In 2017, the last tax year before the $10,000 cap took effect, taxpayers who earned more than $100,000 claimed 91% of the tax benefit for the SALT deduction. That year, the average SALT deduction taxpayers claimed was $23,804 in New York and $5,451 in Alaska, according to Internal Revenue Service data.
The cap on the SALT deduction may affect where people choose to live, since the deduction no longer offsets high taxes. The TCJA, however, expanded other tax benefits that help compensate for the cap. And some states are offering workarounds to help taxpayers deduct additional state and local taxes.
What Is the SALT Deduction?
Taxpayers who itemize deductions on their federal income tax returns can deduct taxes they paid to state and local governments, which can reduce their federal income tax liability.
The SALT deduction can include real estate taxes and either sales taxes or income taxes you’ve paid during the year to state and local governments. If you choose to deduct income taxes, you can deduct money you paid to your state and local government through tax withholding or quarterly income taxes. You can also deduct personal property taxes if your state assesses them.
When you add up those taxes, the maximum SALT deduction you can now take is $10,000. High earners in high-tax states may not be able to deduct a portion of the state and local taxes they paid because of the cap.
In 2018, the top 10 counties with the most state and local taxes paid that were reported on federal tax returns were primarily in California and New York, with one jurisdiction each from Colorado, Connecticut, New Jersey and Virginia, according to the Tax Foundation.
The cap boosted taxes significantly for the highest earners in states with high income and property taxes. For example, Mitchell Freedman, a certified public accountant and personal financial specialist in Westlake Village, California, has a client who pays more than $500,000 in state income taxes and more than $150,000 in real estate taxes on his Malibu, California, home.
“Of that $650,000, he can only deduct $10,000, leaving $640,000 of taxes which he cannot deduct on his federal income tax return,” Freedman says.
The impact was reduced for many taxpayers, however, because the TCJA expanded other tax benefits at the same time it capped the SALT deduction, says Garrett Watson, a senior policy analyst with the Tax Foundation. The law reduced most individual income tax rates and nearly doubled the standard deduction from $6,500 to $12,000 for single filers and from $13,000 to $24,000 for married couples filing jointly.
Boosting the standard deduction means that fewer people are affected by the cap on the SALT deduction. You must itemize deductions on your federal income tax return — rather than take the standard deduction — to claim the SALT deduction. Prior to 2018, about a third of taxpayers itemized their deductions.
“When the standard deduction was doubled, that dropped the itemizers down to about 10%, and now it’s mostly higher earners who itemize,” Watson says.
This Year’s SALT Deduction Cap
Prior to the 2018 tax year, taxpayers who itemized could deduct all eligible state and local taxes they paid during the year, including real estate, personal property, and income or sales taxes. But they can deduct only up to $10,000 in state and local taxes each year for tax years 2018 through 2025.
This $10,000 cap is the same for single taxpayers as it is for married couples filing jointly; married couples do not get a higher cap, but single taxpayers each get a $10,000 cap. Married taxpayers filing separately each get a $5,000 cap.
The current law sets the cap at $10,000 until it expires after the 2025 tax year. It does not adjust the cap for inflation, even though the standard deduction is increased for inflation each year. For example, the standard deduction is increasing by about 7% from 2022 to 2023, Lisa Greene-Lewis, CPA and tax expert with TurboTax, says.
How to Calculate the State and Local Tax Deduction
For your 2022 income tax return, the SALT deduction can include state and local income taxes that your employer withheld from your salary during 2022 (your Form W-2 will show the amount), plus state and local income taxes you paid in 2022 for a previous year (such as taxes you paid with your 2021 state income tax return). Additionally, you can deduct state and local estimated tax payments you made during 2022, including any part of a previous year’s tax refund you chose to have credited to your 2022 state or local taxes.
Some special taxes are also eligible, such as mandatory contributions to a few states’ unemployment funds (see the instructions for Schedule A at IRS.gov for details).
Instead of deducting state and local income taxes, you can choose to deduct state and local sales taxes. But you can’t deduct both income taxes and sales taxes.
You can also deduct state and local real estate taxes and eligible personal property taxes (for example, some states allow you to deduct personal property taxes on cars). Some state and local taxes, such as those on gasoline and car inspection fees, are not deductible.
When you do your taxes, add up all your expenses eligible for the SALT deduction. If the total is more than $10,000, remember that you can include only $10,000 when calculating your itemized deductions.
To determine whether you’re better off itemizing or taking the standard deduction, add up your expenses that are eligible for the itemized deductions and see which figure is higher. A CPA, enrolled agent or other tax professional can help you calculate it, or a tax software program such as TurboTax can add up your eligible expenses and show you which method works best for you.
For tax year 2022, the standard deduction is $12,950 for single filers and $25,900 for married couples filing jointly. The standard deduction is higher for taxpayers 65 and older — $14,700 for single filers and $28,700 for married couples filing jointly if both spouses are 65 or older ($27,300 if one spouse is 65 or older).
Expenses that are eligible for the itemized deductions include the SALT deduction (up to the $10,000 cap), tax deductible mortgage interest, charitable gifts, tax deductible medical expenses that exceed 7.5% of your adjusted gross income and a few other expenses. See the IRS’s instructions for Schedule A for more information.
“If you’re on the border or a little below the standard deduction and it’s coming to the end of the year, you might want to clean out your closest and contribute to a charity — that could bump you up,” Greene-Lewis says.
In 2022, you have to itemize to deduct charitable contributions. In 2021, single filers could deduct up to $300 in cash contributions without itemizing ($600 for married couples), but that break expired. Making some extra charitable contributions before the end of the year — whether they’re in cash or not — could help you increase your eligible deductions if you want to itemize.
State Workarounds for the SALT Deduction Cap
Several states have created workarounds to help some taxpayers who are affected by the $10,000 cap minimize the tax increase.
“States have tried to explore looking at ways they can comply with the IRS regulations and also provide more SALT deduction relief for their taxpayers,” Watson says. “The most common is for owners of passive businesses.”
In some states, if you have a passive business, which includes partnerships, S corporations and some limited-liability companies, you may be able to pay certain taxes as a pass-through entity and deduct more than the $10,000 limit in state and local taxes.
“There’s actually no net increase in taxes paid for those taxpayers, but they get to enjoy that higher than $10,000 SALT deduction,” Watson says. “But you have to have a passive business.”
The specifics vary by state. If you have a passive business, it’s a good idea to work with a tax professional who can help you determine whether these rules apply to you.
“It’s complex, and whether or not one can or should do it must be evaluated on a case-by-case basis,” Freedman says.
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State and Local Taxes: What Is the SALT Deduction? originally appeared on usnews.com
Update 12/02/22: This story was previously published at an earlier date and has been updated with new information.