The State and Local Taxes Deduction Cap – Simplified

In December of 2017, the Tax Cuts and Jobs Act changed the tax code to cap the federal income tax deduction for state and local taxes (SALT) at $10,000 annually. As a result, many individuals are looking for workaround options to retain the effect of the SALT deductions. Before the amendments took effect, individuals who itemized their deductions could deduct state and local property and sales or income taxes without limitation. For states with high property tax rates like Pennsylvania, this was often a needed offset for individuals’ federal income tax liability.

Both married and unmarried individuals are now capped at $10,000 for their state and local property and sales or income taxes. Couples who own multiple properties or have higher incomes and choose to file jointly, may be looking at higher federal income tax liability than previous years. Small business owners operating as pass-through entities who claim the income from their business as individual income on federal taxes are no longer able to deduct the full extent of their state or local income taxes. Lastly, individuals who own more than one property are still subject to the cap, so even though the individual owes property taxes on both properties, they are still capped at $10,000 for both.

Prior to the Tax Cuts and Jobs Act, almost a third of Pennsylvanians itemized their taxes to take advantage of the SALT deductions. For those who itemized, the average SALT deduction state-wide was $11,170 according to Third and State and The Morning Call. This average is even higher for counties with wealthier citizens who contribute more in property taxes. Counties in the southeastern and western parts of the state had more citizens who utilized the SALT deduction with figures closer to 40-45% of individuals. For them, average deductions were closer to $13,000 and above $14,000 in some instances, meaning the tax amendment disproportionately affects higher income individuals. Effectively, this means that the average itemizing individual in Pennsylvania will now face an additional $1,190 in federal income tax liability, and wealthier individuals in the southeastern and western parts of the state are facing, on average, increases ranging from $2,918 to $4,322 according to projections from the Tax Policy Center for the Urban Institute and Brookings Institution.

Pennlive reports that the SALT deduction was one of the six original federal income tax deductions and has been in existence for over 100 years. Due to its lengthy history, many citizens and commentators are turning to the Pennsylvania legislature to retain its effects. For instance, the Tax Policy Center for the Urban Institute and Brookings Institution suggests that Pennsylvania and its local taxing bodies should reduce property and income tax rates to accommodate the $10,000 SALT deduction cap.

There are, however, many reasons why Pennsylvania and the local governments have maintained high tax rates. The revenue derived from property and income taxes often funds public works programs such as roads, schools, construction projects, and public safety measures like ambulance services or the local police force. With Pennsylvania already strapped for cash, it is unlikely that these tax rates will be reduced in the near future.

Individuals attempting to identify and utilize a SALT workaround are cautioned. The IRS has already issued potential guidance that, if implemented, would make New York’s proposed use of charitable contributions to get around the $10,000 SALT cap inoperable. This is a warning for other states looking to enact potential workaround for the SALT cap of TCJA. Since TCJA is still in its infancy, consulting a tax professional will be beneficial for individuals to determine federal income tax liability.

This article was written with contribution from Sarah Rothermel, 3rd year law student at Widener Law Commonwealth.

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