Two years after the 2017 Tax Cuts and Jobs Act passed, it produced some of the most sweeping and significant changes in our industry. Both personal and corporate tax laws were changed and many of these changes were advantageous to individuals and businesses alike. However, after two years of digesting the impact of the law, not all the changes were helpful. One of the most painful changes taxpayers encountered was the cap on the state and local tax deduction (SALT). Total state, local, and property taxes paid for were limited to a maximum of $10,000 ($5,000 each for married filing separately returns).
There have been numerous attempts to circumvent or withdraw the limit. In December 2019, the House of Representatives passed legislation, known as the “Restoring Tax Fairness for States and Localities Act,” which would have eliminated the cap on SALT for 2020 and 2021. The bill also called for increasing the limit to $20,000 for married couples filing jointly in 2019 while raising the highest marginal tax bracket back to 39.6%. However, this bill did not pass the Senate, which largely voted along party lines.
Shortly after the law’s passage, there were many attempts to circumvent the cap. In some areas, individuals attempted to prepay property taxes a year early so they could take advantage of the final deduction in 2017, though these were not successful. Some states, such as New York, attempted to pass measures allowing citizens to pay more in charitable contributions to reduce their state tax burden, shifting their non-deductible state taxes to deductible charitable contributions, which was quickly shut down by the Treasury and the IRS.
Suffice to say, the deduction has been met with resistance due to its significant impact on higher-income individuals in certain states, or those with significant property in high property tax states.
At 1-800Accountant, we saw this spect of the law at the client level. For example, one couple in New York typically had a state tax deduction of approximately $35,000, with another $8,000 in mortgage interest. After the SALT cap was implemented, the previous $43,000 that was counted as an itemized deduction was quickly turned into a max of $18,000 – lower than the 2018 standard deduction of $24,000. Even with the increased standard deduction, this change alone lost this couple $19,000 worth of deductions in their marginal tax bracket of 25%. All of this translated to roughly $4,750 of additional federal taxes. Sadly, there have not been any successful attempts to alleviate this burden, though there are some suggestions for trying to shift some of these taxes back into a deduction.
As tax professionals, we advised our clients that the standard deduction is now higher than in previous years. Taxpayers are significantly more likely to claim that deduction instead of itemizing, a trend we’ve seen explode since the law was passed, especially this year, as more and more taxpayers look to navigate this new reality. Another way we’ve advised clients was to save for charitable contributions strategically. We’ve told clients repeatedly that if the itemization amount is under the Standard Deduction, consider whether you can shift charitable contributions to another year (doubling your contributions in a particular year) to add enough additional itemized deductions to surpass the raised deduction level. After two years, our team can say that the impact the cap on State and Local taxes has been a common concern for our clients in higher-tax states. Strategic decisions and allocation of taxes to business operations may offer additional strategies for recouping some of the tax deductions, but that impact is still being felt by taxpayers. The most important thing clients can do to prepare for this new reality is to plan.