Tax Reform: Itemized Deductions for State and Local Taxes

The recent congressional proceedings relating to Tax Reform efforts have resulted in a focus on the proposed repeal of itemized deductions for state and local taxes (SALT). Specifically, the House plan repeals the SALT deduction but allows a deduction for up to $10,000 of property taxes. The Senate version includes a full repeal of the SALT deduction.

Many commentators have voiced concern that the repeal of the SALT deduction is unfair to taxpayers in high tax states such as California, New York, New Jersey and Illinois. Others argue that the SALT deduction results in an unfair federal subsidy for those high tax states. However, upon closer view, it may be that both claims are somewhat overstated.

For instance, the interaction of the Alternative Minimum Tax (AMT) and the reduction of itemized deductions for higher income taxpayers complicates the analysis. Under current law, SALT deductions are not allowed for the AMT calculation. Thus, for taxpayers paying the AMT, the tax savings value of the SALT deduction is reduced, in some cases to zero. Indeed, in high tax states, it is the SALT deduction itself that throws a taxpayer into an AMT tax situation. Notably, both the House and Senate versions of Tax Reform would eliminate the AMT. In addition, the current tax law reduces the use of itemized deductions, including the SALT deduction, for high income taxpayers, in some cases substantially. Finally, the typically progressive tax rates in high tax states would subject lower income taxpayers in those states to the lower range of tax rates which would reduce the gap in tax rates, if any, as between high and low tax states. Thus, the actual advantages of the SALT deduction in high tax states may be much less than as argued by commentators on both sides of the issue.

Due to the numerous permutations in results occasioned by the interaction of these various tax rules, the real effect of the repeal of the SALT deduction on any particular taxpayer will certainly depend on his or her unique tax situation. Nevertheless, if the SALT deduction is lost in 2018, it may make sense to pay fourth quarter estimates of state taxes and both halves of real property taxes in 2017, rather than in 2018. The reader would be well-advised to address this issue with his or her tax professional.