State and Local Tax Deduction: 2018 and Beyond

 January 29th, 2018    

Changes to the tax code impact everyone. From year to year, changes always occur. They’re expected, and accountants tend to make a habit of taking an end of year tax update webinar or seminar in order to prepare them for the coming filing season.In December of 2017, though, something unusual happened: the new 2018 tax bill was signed into law. This 1,100 page document is the biggest tax overhaul in decades, and will have repercussions for millions of Americans for years to come.

The new tax bill will affect businesses and individuals alike. If you run a business, you’ll be impacted by changes to corporate tax rates, cost recovery provisions, deduction and exclusion reforms, pass-through taxation, Qualified Business Income (QBI) deduction, and more. And, as an individual filer, the list of changes to the code is even longer: you’ll have to worry about changing tax brackets, alterations to the Sunset Provision and Affordable Care Act requirements, new withholding tables, the exemption and phaseout of the Alternative Minimum Tax (AMT), and much, much more.

One item on the list of reforms sticks out, though, as it could have massive implications for individual filers who opt to itemize their deductions. We’re talking, of course, about changes to the rules regarding the state and local tax (or SALT) deduction.

What is the state and local tax deduction? How many people per year opt to use it? How will the new tax reform bill impact your ability to take the SALT deduction?

We’ve put together this quick but comprehensive guide to answer all of your questions about SALT. Read on to learn more.

What is the state and local tax deduction?

Not all individual filers opt to itemize their deductions. It’s possible to take the standard deduction instead. Under the new tax law, the standard deduction has been increased significantly: $12,000 for individual filers, $18,000 for heads of household, and $24,000 for married couples.

However, many taxpayers choose to itemize their deductions, as it allows them to deduct a larger amount from their federal taxable income. As a result, they’re able to save a significant amount in federal income tax each year.

The state and local tax deduction (or SALT) refers to the federal income tax deduction of the various state and local taxes that an individual filer pays throughout the tax year. The following taxes are included under the SALT category:

  • State property taxes
  • Local property tax
  • State and local real estate taxes
  • State and local income OR sales taxes

When the SALT deduction was first introduced alongside the rest of the federal income tax code in 1913, it was virtually unrestricted. Over time, restrictions have been placed on the SALT deduction, including the restriction related to income and sales taxes. Originally, both the state and local income and sales taxes that an individual filer paid could be deducted from their taxable federal income. However, this was later restricted so as to limit the amount that taxpayers could deduct. Now, individual filers must choose to either deduct their state and local income taxes, or their state and local sales taxes–but not both.

Who takes the state and local tax deduction?

Roughly 30% of taxpayers opt to itemize their deductions. In 2014, 95% of these itemizing filers chose to deduct state and local taxes. The majority of them chose to deduct their state and local income taxes rather than their sales taxes, due to the fact that income taxes tend to amount to a larger deduction than sales taxes. However, in certain states where income taxes are minimal or nonexistent, filers may choose to deduct their state and local sales taxes instead.

Traditionally, the SALT deduction has tended to benefit America’s wealthiest taxpayers. Statistically, more than 88% of the benefits derived from state and local tax deductions end up in the hands of filers with more than $100,000 in annual income.

What’s changing with the new tax reform bill? 

As of 2015, the average taxpayer nationwide who opted to itemize their deductions claimed $12,471 in state and local tax deductions. In some instances, certain taxpayers were able to deduct significantly more.

As a result of the new tax reform bill, the amount of state and local tax that an individual filer can deduct is being capped at $10,000 per year. This will impact taxpayers in a couple of ways.

Firstly, some taxpayers will find themselves paying more in federal income taxes. Depending on their income level, the change to the SALT deduction will affect different filers to vary extents. For example, filers earning from $25,000 to $50,000 per year can on average expect to pay an additional $603 in taxes. By comparison, those earning anywhere from $500,000 to $1 million per year could end up paying an average of $21,606 in additional federal income taxes. In the case of higher income earners, though, this isn’t the entire picture: changes to the Alternative Minimum Tax (AMT) could significantly reduce overall tax burden.

Additionally, the cap on the SALT deduction could result in fewer Americans opting to itemize their tax deductions. With the increase in the standard deduction and the cap on the SALT deduction, taking the standard deduction may prove to be more financially advantageous for many Americans.

Who’s the most impacted by the new state and local tax deduction laws?

Data demonstrates that 4.1 million Americans pay more than $10,000 in property taxes alone, and such individuals will certainly be impacted by the cap on the SALT deduction.

Residents of certain states could be particularly hard hit by the SALT deduction cap. In fact, six states–Pennsylvania, Texas, Illinois, New York, New Jersey, and California–collectively account for more than half of nationwide state and local tax deductions. California alone accounts for nearly 20% of annual SALT deductions. Residents of these states may find themselves paying more in taxes as a result of the SALT deduction cap.

How do I help my clients prepare for changes to the SALT deduction?

If you’re an accounting or tax professional, you may be wondering how to help your clients prepare for changes to the SALT deduction. As part of our 2018 Tax Reform Webinars, Basics & Beyond™ will discuss these changes at length. You’ll learn everything you need to know about the tax reform bill, including how to help your clients cope with the new SALT deduction cap. Click here to sign up for a tax webinar today.

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