Since 1913, the federal government has allowed individuals to deduct taxes paid to state and local governments – known today as ‘SALT deductions.’ Taxpayers could deduct income and property taxes paid on their federal income tax returns, which allowed states and localities to raise taxes without residents feeling their full effects.
The SALT deduction is said to benefit high-income taxpayers in high-tax states the most – particularly California, New York, Illinois, and Texas. The mean deduction amount varies greatly according to housing prices, property taxes, etc. but the value of the deduction increases with income. Taxpayers claiming the SALT deduction in these high-tax states paid north of $20,000 on average in state and local tax payments in 2018.
In 2017, the Tax Cuts and Jobs Act restricted the SALT deduction to individual taxpayers and capped limits at $10,000 for state and local income taxes paid. For married couples filing separately, the cap is $5,000. Along with many facets of the TCJA, this limit was set to expire at the end of 2025, but talk of repealing – or adjusting – it sooner has become a point of contention in negotiations for the government’s infrastructure plans and federal budget. So far, The White House appears open to repealing the SALT deduction cap, but Republicans and Democrats must find a solution to offset the billions of dollars of lost revenue.
So, what does this mean for California residents?
- Repealing the cap could help offset the impact of our state’s higher tax burden on individuals.
- Increasing the cap – rather than repealing it – could be a compromise that affords improved tax breaks for high-earning residents but would likely be a temporary solution.
- In lieu of repealing the SALT deduction cap at the federal level, states can opt for a workaround for residents who receive passthrough income via an entity. During the 2021 legislative sessions, roughly a dozen states agreed to allow entities to pay the state income tax and receive the full federal deduction for it, which gives owners who are capped by the $10,000 a tax break. California has adopted this solution.
If you receive passthrough income from an entity, and want to take advantage of this provision, please contact us directly, as this must be completed prior to December 31, 2021.