THE STATE AND LOCAL TAX DEDUCTION UNDER THE TAX CUTS AND JOBS ACT

In anticipation of the recently passed Tax Cuts and Jobs Act (“Act”)#1, some Republicans and a lot of Democrats were concerned and vocal over the proposed, and now enacted, modification to the long-standing deduction for state and local taxes unrelated to a business (“SALT Deduction”).  For decades and decades, a taxpayer who itemized deductions was allowed to deduct certain taxes paid to state and local governments from the taxpayer’s federal gross income.   

Prior to the Act, a taxpayer was allowed to (i) deduct state and local property taxes, and (ii) state and local income or sales taxes (whichever was greater).  Additionally, a taxpayer was allowed to take the SALT Deduction without regard to any limitations (e.g., a cap on the amount paid that was deductible).  If a taxpayer paid local real property tax of $7,000 (in connection with a personal residence), state income tax of $13,000, and state sales tax of $8,000 (related to personal costs), the taxpayer could deduct $20,000 ($7,000 in real property tax and $13,000 in state income tax (since the amount of state income tax paid was greater than the state sales tax paid)).  

In terms of SALT Deduction utilization, taxpayers in all states take advantage of the SALT Deduction, albeit more so in traditionally Blue states and less frequently in Red states.  In Maryland, Connecticut, New Jersey, the District of Columbia, and Virginia, for example, 41% of taxpayers utilized the SALT Deduction on their Federal income tax return.  The taxpayers in these states took a SALT Deduction, on average, of $6,095.#2  On the other hand, in West Virginia, South Dakota, North Dakota, Tennessee, and Alaska, only 19% of taxpayers utilized the SALT Deduction; in these states the SALT Deduction, on average, amounted to $1,159 per taxpayer who was able to utilize it.#3

Pursuant to the new Act, currently effective for tax years 2018-2025, Congress has modified the SALT Deduction by limiting the amount of a taxpayer’s total deduction for state and local taxes to $10,000 if the taxes are unrelated to a taxpayer’s trade or business or other profit-seeking activity.#4  Under the Act, and still assuming none of the state and local taxes in our previous example were paid in connection with a profit-seeking activity (e.g., an investment property), the taxpayer would be limited to taking a SALT tax deduction of $10,000, which is $10,000 less than the taxpayer’s SALT Deduction prior to Congress enacting the Act.

Across the country, state legislators and governors appear receptive to finding solutions or workarounds to the new $10,000 cap on the modified SALT Deduction.  One solution gaining steam involves the reclassification or elimination of state and local property taxes as, or in favor of, employment or payroll taxes.  Another popular workaround involves allowing a taxpayer to voluntarily pay state and local income tax: thereby allowing the taxpayer to classify the payment of state and local taxes as a charitable contribution (under the Act there is still no limit to a taxpayer’s amount of deductions for charitable contributions).  

Given the high state and local tax burdens in a number of states, it seems likely that states will adopt legislation in favor of one or more of the above two approaches.  Whether Congress attempts to find a bipartisan solution to states’ solutions to the much maligned $10,000 limitation on a taxpayer’s SALT Deduction, however, is another story altogether.

#1 Public Law 115-97, “An Act to provide for reconciliation pursuant to Titles II and V of the concurrent resolution on the budget for fiscal year 2018”.
#2 Top five (5) states, by percentage, with taxpayers utilizing the SALT Deduction.
#3 Bottom five (5) states, by percentage, with taxpayers utilizing the SALT Deduction.
#4 Internal Revenue Code §§ 164(a) and (b)(6).