The Tax Cuts and Jobs Act (TCJA) limits itemized deductions for state and local tax (SALT) payments for 2018 through 2025. This unfavorable tax law change is especially unpopular in states with high income or property taxes (or both). The limitation remains in effect, despite repeated calls to repeal it. (See “How Will the SALT Rules Shake Out?” at right.)
Fortunately, there may be ways to maximize your annual deduction if you keep a close watch on your tax situation during the year. Plus, some owners of pass-through entities may benefit from a special SALT workaround.
How Will the SALT Rules Shake Out?
There’s been some bipartisan support in Congress for removing the SALT deduction cap. Since 2019, the House has passed three bills restoring the full SALT deduction, but the Senate didn’t act on them. Similar legislation was introduced in January 2023.In addition, a caucus of House lawmakers from both sides of the aisle has been formed to coordinate efforts for lifting the cap. Despite their best intentions, they continue to face an uphill battle. Stay tuned.
Basics of the Limitation
For starters, a SALT deduction is available only if you itemize deductions. People who claim the standard deduction will receive no tax break for SALT payments.
Prior to the TCJA, people who itemized deductions could claim a tax break, without regard to any annual dollar limits, for any combination of:
- State and local property taxes, and
- State and local income taxes (or sales taxes).
If you itemized, you could claim SALT deductions with other itemized deductions on Schedule A. This often represented one of the biggest deductions on the personal returns of individuals in certain states.
For 2018 through 2025, the TCJA caps the annual SALT deduction at $10,000 ($5,000 if you use married filing separately status). The limitation still applies to state and local property taxes and income taxes (or sales taxes).
However, personal foreign real property taxes can no longer be deducted at all. So, if you’re lucky enough to own a vacation villa in France or a beach condo in Costa Rica, you’re out of luck when it comes to deducting the property taxes.
In addition, there’s no deduction carryforward for state and local taxes paid in excess of the $10,000 limit. But the SALT limit doesn’t apply to taxes paid in connection with 1) a trade or business, or 2) the production of income.
Itemized Deductions vs. the Standard Deduction
Other changes in the TCJA may encourage you to claim the standard deduction rather than to itemize deductions on Schedule A. Specifically, the TCJA effectively doubled the standard deduction, while providing for inflation indexing of those amounts. For 2018 through 2025, the standard deduction increased to an inflation-adjusted $12,000 for single filers and $24,000 for married couples who file jointly. The inflation-adjusted figures are:
- $12,950 in 2022 and $13,850 in 2023 for single filers, and
- $25,900 in 2022 and $27,700 in 2023 for married couples who file joint returns.
When you combine these increases with the SALT payment cap, you’ll often come out ahead with the standard deduction.
To illustrate, suppose you’re a single filer with $20,000 of SALT payments, $1,000 of charitable donations and no other itemized deductions in 2022. In this case, if you itemized, the most you could deduct is $11,000 ($10,000 SALT deduction plus $1,000 charitable deduction). Thus, you’re better off with the $12,950 standard deduction.
Income vs. Sales Tax
Despite the temporary increase to the standard deduction, some taxpayers still benefit by itemizing deductions. If you’re in this boat, it’s important to collect the proper documentation to substantiate your deductions and evaluate your options.
If your state and local property taxes exceed $10,000, things are simple: Keep a copy of your property tax bill and take a $10,000 SALT deduction. Your state and local income taxes (or sales taxes) are irrelevant in this situation; they provide no additional federal tax break.
If you have less than $10,000 of property taxes, you’ll need to evaluate whether to claim state and local income tax or state and local sales tax — you can’t claim both on Schedule A. This decision is a no-brainer for most people who reside in a state with high income taxes, such as California, Hawaii, Illinois, New York or New Jersey. In these locales, you’ll usually want to deduct state and local income taxes.
However, it may be advantageous to deduct state and local sales tax if you’re retired and don’t have much income or if you live in one of the nine states without any state income taxes on wages — Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming.
If you decide to claim state and local sales taxes, the recordkeeping can be tricky. You can deduct the actual amount of sales taxes you pay if you retain the necessary records (such as receipts and credit card statements).
Alternatively, you may find it more convenient to use the IRS-approved table. With the simplified method, you refer to the state where you reside and enter the flat amount for the size of your family. Then you compare the table amount to your actual expenses and deduct the higher amount. If you use the IRS table, you can add the cost of certain “big-ticket items” to the flat amount. This includes:
- The purchase or lease of a vehicle,
- The purchase of a boat or aircraft, and
- Purchases for a substantial addition or renovation of a home.
When these items are tacked onto the amount from the IRS table, the simplified method could result in a bigger deduction than the actual expenses method. Even if you use the simplified method, however, you’ll need records for any big-ticket expenses to support your claims.
SALT Cap Workarounds
In response to complaints about the SALT cap, many states have authorized workarounds that allow a “pass-through entity” to pay state income taxes at the entity level. The entity deducts the payments, which are then passed through to the individual owners as deductions or credits, effectively bypassing the SALT cap at the individual level. Partnerships, S corporations and certain limited liability companies are treated as pass-through entities.
According to the latest statistics from the American Institute of Certified Public Accountants (AICPA), 30 states have enacted a version of such a workaround, while five others are considering it. The AICPA says that only seven states with a personal income tax aren’t addressing proposals on this issue. The nine states with no income tax round out the list.
Important: A workaround can trigger other tax issues for pass-through entities, such as valuations of business property. In addition, each state has taken a slightly different approach to SALT workarounds, which creates a complex situation for businesses with a multistate presence. Your tax advisor can provide guidance.
For More Information
The limit on SALT deductions is controversial, and varying state workarounds add complexity. Contact your RWC tax professional who can help you navigate the rules and chart the optimal course based on your situation.