State and Local Taxes (SALT)
Today we are going to talk about a highly-debated area of the tax code over the last few years, and that is the deduction for state and local income taxes. Again, we are talking about itemized deductions here, so remember that the majority of this conversation is irrelevant to you if you don’t own a house.
Income Tax/Sales Tax Deduction
The first part of this deduction is for state and local income taxes. This is the money that you’ve paid throughout the year to state agencies. For many people, this is simply the amount of state withholding tax on your W-2 from your job, plus any taxes you owed to the state when filing last year. Because your 2022 taxes were filed in 2023, if you owed tax, you likely paid it in 2023. If you’re self-employed and you make estimated payments, this deduction is made up of any estimated tax payments or balances due that you paid in the 2023 calendar year.
Some individuals do not pay state income taxes. This may be because they live in a state without income taxes (Texas, Florida, etc.). It may also be because they are retired and living in Illinois. If you’re a retired individual in Illinois, most retirement income is non-taxable, so some retired folks have no state tax liability. For people like this, the federal government allows you to instead take a deduction for the sales taxes you paid throughout the year. Since hardly anyone will be able to track down this exact number, they provide a general table that you can use to calculate an estimated deduction for this. It’s based on your income and location, and is provided in the instructions in schedule A. You can also add in the sales taxes for any major purchases you had, such as a car or a boat.
This is an either/or situation, so you either take sales taxes or income taxes. If you pay income taxes, it is almost always the more beneficial deduction.
Real Estate Taxes
The next thing that we add to this deduction is any real estate taxes that you paid during 2023. Again, this is only relevant if you own a house. This is any amount that was included in your mortgage payment for real estate taxes, or any amount you paid to your county separately. If you have vacation properties, you can generally include those amounts as well. However, you cannot include any business property taxes for this deduction. In other words, your rental properties are not included. These taxes are instead deducted on the rental property schedule (schedule E), which is more beneficial for you anyway.
On schedule A, there is also a line for personal property taxes. These are less common, but in some states, you are charged an annual tax for having things like boats and cars. This does not necessarily include your license plate renewals – it’s really only for taxes that are based on the estimated value of your property, similar to property taxes. Indiana is one example of a state that has this.
The $10,000 Cap
This is the most important concept and the item that is frequently debated in congress. As part of the Tax Cuts and Jobs Act (Trump tax law), the state and local tax deduction is capped at $10,000 total. This is true whether you’re single or married – it’s just $10,000. So we take the total amount of state income taxes we paid and add it to the property taxes we paid. If this figure is higher than $10,000, our deduction for this section is limited to $10,000.
The reason this is debated very frequently is because in many high-tax states (cough cough Illinois), we have some pretty high property taxes. In many other states (cough cough California), income taxes are really high. If you live in one of these states, your itemized deductions may have been higher under prior tax laws than the increased standard deduction is now. This is why you have many representatives from these high-tax states that have formed a bit of a coalition. This coalition has said that they won’t consider many other tax law changes, such as the increased child tax credit or changes to R&D credits, without first removing or increasing the SALT cap.
We’ll be watching for changes to the SALT cap over the next few months as congress negotiates more spending initiatives and potential tax extenders. There is a good chance there willbe some changes here. If you have questions about how any of this works, please feel free to contact us!