Recent changes to the state and local tax deduction (aka the SALT tax deduction) continue to be a hot topic for taxpayers in the U.S. There is now a $10,000 cap on the deduction for state and local taxes that may be claimed on your federal tax return.
That means if you live in a high-tax state, like California or New York, chances are high you saw your tax bill go up after the Trump tax law changes in 2017.
Will Congress repeal the $10,000 limitation on the deduction for state and local taxes? That still remains to be seen but is definitely an area of focus for Democrats anxious to appease voters in blue states. Perhaps recent migration patterns from high-tax states to low- or no-tax states might speed up a potential solution.
Check out this article to learn more about SALT tax deductions and find out ways you may be able to deduct state and local taxes paid above the $10,000 limit.
What is the SALT Tax Deduction?
SALT stands for “state and local tax.” This includes any taxes paid to state and local governments. The SALT tax deduction refers to the federal income tax deduction available to those who itemize their deductions instead of claiming the standard deduction.
Taxpayers will itemize deductions if their total itemized deductions (which include other deductions such as charitable contributions and certain medical expenses) exceed the standard deduction amount for the year. Itemized deductions are claimed on Schedule A filed with your Form 1040 individual income tax return.
State taxes may include taxes paid to a state, such as New York. Residents of New York, and others who have sufficient nexus to the state, are required to pay taxes to the state of New York every year.
Local taxes are taxes paid to a local government, such as New York City. If you are a resident of New York City, you pay additional taxes to the city on top of your New York state taxes due.
Types of State and Local Taxes
There are a number of different types of taxes that may be paid to state and local governments. However, not all taxes are deductible. Examples of taxes that are not deductible are gas taxes, car inspection fees, and certain town assessments for things like sewer system or road improvements.
Keep in mind that the $10,000 limit applies to all state and local taxes. That means when you add up all of the taxes paid during the year, regardless of the type of tax, you can only deduct up to $10,000.
Some states (Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, Wyoming) do not have income taxes. However, that does not mean their residents pay no state and local tax. There may be other types of taxes paid to the state that are eligible for the SALT tax deduction.
Examples of state and local taxes eligible for the SALT deduction include:
State and local income taxes
State and local income taxes are taxes paid on your income earned during the year. This may include tax withheld from your paycheck or paid on your salary. It also includes taxes paid on other sources of income such as investment income (dividends, interest, capital gains) or any other source of income you earned during the year.
State and local sales or use taxes
Sales taxes are taxes paid on the sale of certain goods or services. Taxpayers will typically deduct state and local sales taxes if they exceed state and local income taxes due that year.
You can deduct either income taxes or sales taxes. However, you are not permitted to deduct both. Therefore, if you decide to deduct sales taxes paid, you will not also be able to deduct state and local income taxes.
Use taxes are similar to sales taxes. States that have use taxes apply the tax when certain goods are bought in a state with no sales tax to be used within your home state.
Real estate or property taxes
You may also deduct real estate taxes paid to a state where you own real property.
Real estate taxes are taxes paid on real estate you own. These are also often referred to as property taxes.
Personal Property Taxes
Some states have taxes on personal property. Examples of personal property often subject to these taxes include cars or boats.
Cap on SALT Tax Deductions
Before the Tax Cuts and Jobs Act of 2017, there was no cap on the amount that could be deducted on a federal tax return. However, the tax law changes introduced a $10,000 cap on the total amount of the deduction that could be claimed.
The $10,000 limit applies to both single and married filing jointly filers. The cap is reduced to $5,000 for filers who are married filing separately.
The deduction remains in effect through the 2025 tax year. That means if Congress does not make any changes to the current law, the SALT tax deduction cap will expire after 2025. Taxpayers could then go back to claiming a deduction for all state and local taxes paid starting in 2026 with no limit.
The SALT tax deduction cap was introduced to offset tax cuts associated with the other tax law changes under President Trump. Many believe the change was politically motivated given the cap would impact residents of blue states (which typically have higher state tax rates) than red states (which typically have low to no state tax rates).
How to Claim the SALT Tax Deduction
As previously noted, the SALT tax deduction is only available for taxpayers who itemize their deductions. Taxpayers are permitted to make the determination of whether to itemize vs. claim the standard deduction each year based on which provides the best result.
The process for claiming the SALT deduction on your tax return is pretty straightforward.
Add up all eligible state and local taxes paid for the year
Calculate the total amount of tax you paid for the year to state and local governments. These can include estimated tax payments, amounts withheld from your salary on your W-2, taxes paid with the state and local tax return, and amounts paid with an extension filed to extend the deadline for the return.
Add up your total itemized deductions
Add your total eligible state and local taxes for the year to your other itemized deductions. These itemized deductions are the amounts claimed on Schedule A of your tax return. You can find the instructions for completing Schedule A here.
Determine whether you should itemize vs. claim the standard deduction
Once you have your total itemized deductions calculated, you can then compare that amount to the standard deduction available for the year. You should end up claiming the higher of those two numbers.
The standard deductions for 2021, 2022, and 2023 are listed below.
|Married filing jointly
The standard deductions available are slightly higher for taxpayers who are 65 years or older.
File Schedule A with your tax return, if itemizing
If you are better off itemizing your deductions under Step 3, you should file Schedule A with your tax return. The state and local taxes paid are reportable on Line 5 of Schedule A.
The Future of the SALT Tax Deduction
As with several elements of the 2017 tax law changes under President Trump, the cap on the SALT tax deduction is temporary. It is only applicable for tax returns filed for the 2018 through 2025 tax years.
Several Democrats, many of whom come from liberal high-tax states like New York, have come out against the ceiling. A few have tried, but ultimately failed, to eliminate or raise the limit.
A fight over the cap has already proven to be a hurdle in passing budget packages. Most recently, a plan to change the SALT tax deduction was removed from the Inflation Reduction Act, an economic package President Biden signed in August 2022.
In the meantime, several states, including New York, New Jersey, and California, have enacted workarounds that allow for additional deductions above the SALT cap. Read more below about potential planning opportunities to deduct state and local taxes above the $10,000 ceiling.
Nonetheless, these workarounds will only benefit those who own certain types of businesses, such as limited liability companies, partnerships, and S Corporations. Individuals who aren’t business owners are likely stuck with the $10,000 cap for the next few years, unless there is a law change.
Planning Opportunities to Increase the SALT Deduction
In response to residents complaining about the $10,000 limit on SALT tax deductions, many states have enacted workarounds that can allow you to deduct more than $10,000 on your federal return. These workarounds will have the largest impact in states with high tax rates, such as New York, California, and New Jersey.
The Pass-Through Entity Elective Tax
The state workarounds are done through what is called a pass-through entity elective tax or PTE tax deduction. This is also commonly referred to as the PTET deduction. In some cases, the PTE tax deduction can allow taxpayers to deduct significantly more than $10,000 state and local taxes paid during the year.
Each state has its own rules for applying the PTE tax deduction. Therefore, it is important that you work with a CPA or tax preparer who has a good understanding of your state’s rules and the deadlines for making any required elections or estimated payments.
States with a SALT Cap Workaround
Currently, 29 states and 1 city (New York City) have enacted a version of the PTE tax deduction. These include:
|New York City
How the PTE Tax Deduction Works
In simple terms, the PTE tax deduction works by applying the tax at the entity level instead of at the individual shareholder level. That means the entity itself will pay the tax on its net income.
The shareholders or owners of the entity will then be able to receive a credit for any tax paid by the entity and/or the amount of taxable net profits flowing to the owners will be reduced by the taxes paid by the entity. The net effect is that you are able to reduce your federal taxable income by more than you would otherwise be able to deduct under the $10,000 SALT tax deduction cap.
Most states have a deadline for making the election and may require the entity to make estimated tax payments for any PTE tax amounts due during the year. This can be difficult to estimate at the time the payment is due and may result in you overpaying the estimated tax bill for the year to make sure your election remains valid.
Some states only allow residents to claim the PTE tax deduction. However, other states may allow anyone with income subject to tax in that state to use the SALT cap workaround.
There is also some uncertainty in some states as to whether residents would be allowed to claim a credit against their home state tax for PTE taxes paid in other states.
It is not always advantageous to make the PTE election. In some cases, you may be worse off after making the election. Always work with a qualified tax preparer in making the election.
In many cases, the election is irrevocable, meaning that once you make it, you are stuck with it. Be extra careful in these states because you may not be better off making the election. For example, businesses with little to no net income can end up paying a mandatory minimum entity level tax that would not otherwise have been due if the election had not been made.