SALT deduction

What is the SALT deduction?

The SALT deduction enables some taxpayers who itemize, versus claiming a standard deduction, to deduct from their federally taxable income certain state and local taxes they have already paid.

The Tax Cuts and Jobs Act (TCJA), enacted in December 2017, limited the itemized deduction for state and local taxes to $5,000 for a married person filing a separate return and $10,000 for all other tax filers, as explained by the IRS. The limit applies to tax years 2018 to 2025. Previously, there was no limit.

What is the purpose of SALT deduction?

The SALT deduction avoids double taxation by counteracting some federal taxpayer liability, which is done by excluding income already taken in taxes for state and local government services.

States with high state and local tax rates that provide more government services typically see the greatest number of taxpayers claiming the SALT deduction. These often include such high-income states as New York, Connecticut, New Jersey, and California, to name a few.

How does the SALT deduction work?

The SALT deduction enables certain taxpayers to reduce their federally taxable income by the amount of state and local taxes they paid that year, up to $10,000 — $5,000 for married who file separately.

This amount consists of property taxes plus local and state income taxes or state and local sales taxes, but not both. Therefore, taxpayers who itemize must choose between deducting their income taxes or sales taxes.

Those who do itemize often choose to deduct their state and local income taxes, especially if they live in a state with high-income taxes. On the other hand, taxpayers who live in states with higher sales tax, but low or no-income taxes — like Texas or Louisiana, for example — may find it more beneficial to deduct sales tax if they itemize.

Taxpayers claim the itemized deductions on Form Schedule A, which is the Form used for making itemized tax deductions.

What is an example of a SALT deduction?

To further illustrate how the SALT deduction works, consider the following example.

When filing their 2023 tax return, the taxpayer decides to itemize their deductions versus claiming a standard deduction. They paid $10,000 in annual property taxes and $6,000 in state income taxes. In this example, let’s say the taxpayer’s income tax rate is 24%.

In total, the taxpayer paid $16,000 in eligible state and local taxes. Under current law, the maximum SALT deduction is $10,000. Given their 24% tax rate, the taxpayer’s deduction would reduce their 2023 income tax liability by $2,400: $10,000 deduction x 24% tax rate.

Which taxes and fees are not covered by the SALT deduction?

According to the IRS, the taxes and fees that taxpayers cannot claim as SALT deductions include, but are not limited to:

• Federal income taxes
  
• Social security taxes
• Transfer taxes, such as taxes imposed on the sale of property
• Stamp taxes
• Homeowner's association fees
• Estate and inheritance taxes
• Service charges for water, sewer, or trash collection

Knowing which taxes and fees can or cannot be deducted can reduce individual state and local taxes, especially in states with higher tax rates. With the implementation of a tax-reduction tool for businesses, some pass-through entities can also reduce their federal tax liabilities.

What is the SALT deduction cap?

The SALT deduction cap limits the itemized deduction for state and local taxes to $5,000 for a married person filing a separate return and $10,000 for all other tax filers, as explained by the IRS. 

The SALT cap was established with the passage of TCJA in 2017. Prior to TCJA, there was no cap on the SALT tax deduction, so taxpayers could deduct 100% of their state and local taxes paid.

The SALT cap has stirred much debate, especially within high-tax states, as opponents argued that the SALT cap was unconstitutional. In 2018, the governments of New York, New Jersey, Connecticut, and Maryland filed a lawsuit against the Treasury Department and IRS.

The SALT cap, however, was ultimately ruled to be constitutional. In 2022, the Supreme Court declined to review the Second Circuit’s decision in New York v. Yellen (CA 2 2021), which held that the SALT cap is constitutional.

Why was the SALT deduction capped?

A key driver for implementing the SALT deduction cap was to help increase federal revenues by limiting deductions. Pre-cap SALT deduction was one of the largest federal tax expenditures, costing the U.S. Treasury an estimated $100 billion a year. 

In fact, the SALT deduction was the fifth largest tax expenditure in 2017, the year before the cap was implemented. That year, the federal government lost nearly $70 million in tax revenues.

Who benefits from a SALT deduction?

Those taxpayers with higher tax liabilities in jurisdictions with higher state and local tax rates will likely see the most significant benefits in claiming the SALT deduction. Typically, they face higher income tax bills and own property with property taxes to deduct.

In fact, before the $10,000 SALT cap under TCJA, taxpayers with income greater than $100,000 accounted for the overwhelming majority (91%) of those claiming SALT deductions. These taxpayers were concentrated in six states: New York, Pennsylvania, New Jersey, California, Texas, and Illinois.

According to estimates by the Tax Policy Center, repealing the $10,000 SALT cap would “overwhelmingly benefit high income households.” Howard Gleckman, senior fellow in the Urban-Brookings Tax Policy Center at the Urban Institute, wrote in a blog post, “Households making $1 million or more a year would receive half the benefit of repealing the $10,000 federal cap on the state and local tax (SALT) deduction, according to new estimates by the Tax Policy Center. Seventy percent of the benefit would go to those making $500,000 or more.”

What is the SALT cap workaround?

The SALT cap workaround is an elective pass-through entity tax (PTET) that numerous states have enacted since the implementation of the SALT deduction cap. This workaround can be a beneficial tax-reduction tool for some pass-through entity (PTE) business owners, enabling them to avoid the $10,000 SALT deduction cap on deducting state and local taxes on federal individual tax returns.

Since the passage of the TCJA, numerous states have taken a closer look at — and implemented — the workaround to the $10,000 cap. To date, more than 30 states have authorized SALT cap workarounds for some PTEs.

The SALT cap is set to expire at the end of 2025; however, if the cap is extended or made permanent, taxpayers in those states with a SALT cap workaround may still reap the benefits.

The specifics vary by state, but for some PTE owners — including S corporations, some limited-liability companies (LLCs), and partnerships — the SALT cap workaround may enable them to indirectly deduct state and local taxes they’ve paid beyond the $10,000 SALT cap.

There are several ways in which the SALT cap workaround can potentially benefit some PTE owners. These include:

• Some PTE owners may find that the SALT cap workaround results in a greater net benefit than an itemized deduction, which the net investment income tax and alternate minimum tax might offset.
  
• Some individual PTE owners may reap the benefits of taxes paid by the PTE, reflected in the reduction of their shares of PTE income. If they had paid state and local taxes directly, they would have been subject to the $10,000 SALT cap.
  

It is important to note that, in some instances, the SALT cap workaround can result in other tax issues for PTEs, such as valuations of business property.

Does the SALT deduction cap expire?

Under TCJA, the SALT deduction cap applies to tax years 2018 to 2025. This timeframe means the SALT cap is set to expire in 2026.

In the meantime, several efforts are underway to restore the SALT deduction. Such developments include:

- Relaunched the bipartisan SALT Caucasus for the 118th Congress to restore the SALT deduction

- Introduced the SALT Fairness Act of 2023 (H.R. 160), which would repeal the SALT deduction cap created under TCJA 

- Introduced the Middle-Class Tax Relief Act, which raises the cap on SALT deductions from $10,000 per household to $100,000 per single filer and $200,000 per married couple

There have also been efforts to make the SALT deduction cap permanent. In February 2023, Congressman Vern Buchanan (R-Fla.) announced reintroducing the TCJA Permanency Act (H.R.976). This legislation looks to make permanent tax cuts for individuals and small businesses originally enacted as part of TCJA, including the $10,000 SALT deduction cap.

This information was last updated on 03/22/2024.