Posted by Income Taxes and Bookkeeping LLC

Changes to SALT (State and Local Tax) Deductions

Changes to SALT (State and Local Tax) Deductions

State and Local Tax Deduction (SALT) allows taxpayers in high tax states to deduct local tax payments from their federal tax returns. The tax plan that President Trump signed in 2017 called the Tax Cuts, and Jobs Act set a cap for the SALT deduction. As of fiscal 2018, the maximum SALT deduction available was $10,000. There was no limit prior to the 2018 fiscal year. We took a look at what the reduced deduction meant for residents of high-tax states such as New York, California, and New Jersey. If you're concerned about the effect of these changes on SALT, consider working with a tax expert to manage the impact of taxes on your financial plan.

How SALT Deductions work

Taxpayers who itemize their deductions (i.e., don't take the standard deduction) can deduct what they paid from certain state and local taxes. This SALT deduction includes property taxes, income taxes, and sales taxes. Concretely, anyone who itemizes can deduct property taxes but must choose between deducting income tax and sales tax. Most choose to deduct income tax because these payments often outweigh sales tax payments. Residents of high-income states (New York, California, Maryland, and New Jersey, to name a few) often choose to deduct local and state taxes if they itemize. Residents of states with high sales taxes (Texas, Louisiana, and others) and low or no income taxes often choose to deduct itemized sales tax. However, property taxes and income taxes, not sales taxes, are the major drivers for the SALT deduction.

It is important to know the limit, as the standard deduction in 2021 is $12,550 for individual taxpayers and $12,950 in 2022. Therefore, you should have an additional $2,550 of itemized deductions in 2021 and $2,950 in 2022, in addition to the SALT deduction, to be able to itemize.

Who uses the SALT Deduction?

Not all Americans benefit from state and local tax deductions. Higher-income taxpayers are more likely to itemize and therefore benefit from the SALT deduction. The higher you earn, the more valuable your tax deductions will be to you in general because you are taxed at a higher tax rate.

The federal government effectively subsidizes high-income people in high-productivity states and cities by deducting state and local taxes. (Any federal deduction is a subsidy.) Not surprisingly, wealthy residents of wealthy states are more likely to pay SALT. They also have the highest average deductions on SALT. 

Those who will benefit from the property tax deduction tend to be those with expensive housing in wealthy communities. Taxpayers who deduct state and local income taxes tend to have high incomes in wealthy states. Even states and cities with high-income taxes tend to have great opportunities, like California and New York.

Why is the SALT deduction important?

State and local tax deductions have been around since 1913 when the United States introduced our federal income tax. Supporters of the SALT deduction, such as the National Association of Governors, point out that state and local taxes on property, sales, and income are mandatory. Taxpayers cannot get out of it. Its elimination would constitute double taxation for those in favor of the deduction.

Also, the SALT deduction is one of the most important federal tax expenditures. In addition to the mortgage interest deduction, excluding tax on employer-funded pensions and health benefits, preferential capital gains tax rates, and deferral of tax deferrals on corporate income, the SALT deduction provides the federal government with billions of lost revenue opportunities. 

So who will miss the state and local taxes deduction the most? According to a 2016 report from the Center for Fiscal Policy, Taxpayers who earn over $100,000 in income would have the largest tax increases both as a percentage of income and in dollars. Eliminating the deduction altogether would raise taxes by about a quarter of taxpayers, and reducing the deduction (as Congress intends to do) would affect about half of the population.

Taxpayers with incomes over $500,000 will get hit the hardest. Still, the loss of their deductions can also be offset by lowering the top federal income tax rate, doubling the property tax deduction, and a reduction in income tax from 23.8% to 21%.

Low-income people would be less directly affected by the reduction in the SALT deduction but would still be indirectly affected. The same Center for Fiscal Policy report found that changing the SALT deduction could change state and local government revenues. In response to people paying more federal taxes, these governments can choose to lower their local tax rates. This would leave them less to spend on government-sponsored programs and services.

How the reduced SALT deduction will affect taxpayers

California, Connecticut, New Jersey, Massachusetts, Rhode Island, Illinois, Maryland, New York, Vermont, and the District of Columbia have the highest average national tax deductions and local. Here is how these deductions are distributed:

  • California Taxpayers: In the 2014 fiscal year, 33.86% of California tax returns included a local and state taxes deduction. The average deduction for California SALT was $17,148.35.

  • Connecticut Taxpayers: Connecticut residents receive the second-highest average deduction for state and local taxes. 41.04% of Connecticut's returns included a SALT deduction in 2014. Connecticut's average deduction for state and local taxes was $18,939.72.

DC Taxpayers: Because homes in Washington are so expensive, residents tend to pay a lot in property taxes. Income tax in the district is also high. So it's no surprise that 39.19% of DC will include state and local tax deductions. The average value of these deductions was 

  • $15,452.40.

  • Illinois Taxpayers: 32.34% of Illinois tax returns deducted local and state taxes paid in 2014. The average SALT deduction for these Illinois tax returns was $12,877.51.

  • Maryland Taxpayers: 45.04% of Maryland tax returns included a state and local tax deduction in 2014. This is the highest percentage of returns requiring SALT deductions in any state. The average value of these deductions was $12,442.78.

  • Massachusetts Taxpayers: 36.73% of Massachusetts tax returns involved state and local tax deductions. The median deduction for SALT in Massachusetts was $14,760.99.

  • New Jersey Taxpayers: Residents of New Jersey pay very high income and property taxes. So it's no surprise that 41% of New Jersey tax returns require a local and state tax deduction. The average value of this deduction was $17,183.33.

  • New York Taxpayers: According to the Internal Revenue Service data, New Yorkers enjoy the highest average deduction for SALT. In 2014, 34.14% of New York tax returns included a local and state taxes deduction. The median value of these deductions for the New York SALT was $21,038.02. New Yorkers will pay particularly high tax rates because of the local income taxes calculated there.

  • Rhode Island Taxpayers: Although Rhode Island might be a small state, its residents tend to have high incomes and high property taxes. As a result, 32.83% of Rhode Island tax returns deducted SALT payments. The average deduction for Rhode Island SALT was $12,138.75.

  • Vermont Taxpayers: Finally, at the top of our list of the top 10 states with the highest average deduction for local and state taxes in Vermont, where 27.41% of returns had SALT deductions. The average value of Vermont's state and local tax deductions was $11,843.95.

Last Words

Is the reduction of SALT deduction just a problem for the rich? Yes and no. It is probably more correct to say it is about a rich-person-in-a-blue-state problem. Heavily taxed residents in California, DC, Massachusetts, Illinois, Maryland, Connecticut, New York, and New Jersey would be hit the hardest. Plus, you don't have to be wealthy to be impacted by the SALT deduction limit. Middle-class Americans, especially those who own a home and pay significant property taxes, may also face higher taxes.



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