Update: President Trump signed a tax reform bill into law on Dec. 22, 2017. For more details on the new tax code see this article. The law is the most sweeping tax reform in decades and includes reducing the federal tax deduction for state and local taxes. Lets take a closer look at what it means for residents of high-tax states like California, New York and New Jersey when the state and local tax (SALT) deduction is reduced.
How State and Local Tax Deductions Work
Currently, taxpayers who itemize their deductions (meaning they don’t take the standard deduction) can deduct what they’ve paid in certain state and local taxes. That deduction includes state and local property, income and sales taxes.
Anyone who itemizes can deduct their property taxes, but filers must choose between deducting their income taxes or deducting their sales taxes. Most choose to deduct their income taxes because those payments generally exceed sales tax payments. Residents of states with high income taxes (California, New York, New Jersey and Maryland, to name a few) generally opt to deduct their state and local income taxes if they itemize. Residents of states with high sales taxes (Louisiana, Texas and others) and low or nonexistent income taxes generally opt to deduct their sales taxes if they itemize. However, property taxes and income taxes – not sales taxes – are the primary drivers of the SALT deduction.
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Who Uses the SALT Deduction?
Not every American takes the state and local tax deduction. High-income filers are much more likely to itemize and therefore more likely to take the SALT deduction. The higher your income, the more valuable tax deductions are to you in general because you’re taxed at a higher rate.
With the deduction for state and local taxes, the federal government is effectively subsidizing high earners in high-productivity states and cities. (Any deduction the federal government offers is a subsidy.) As you might expect, wealthy residents of wealthy states tend to have the highest average deduction for state and local taxes. According to the Tax Foundation, people with incomes over $100,000 receive more than 88% of SALT deduction benefits.
Those who stand to gain from deducting their property taxes tend to be those who have expensive homes in prospering communities. Filers who deduct their state and local income taxes tend to be high earners in thriving states. States and cities with high income taxes also tend to be high-opportunity states like California and New York.
Why the SALT Deduction Matters
The deduction for state and local taxes has been around since 1913, when the U.S. first instituted our federal income tax. Defenders of the SALT deduction, such as the National Governors Association, point out that state and local income, real estate and sales taxes are mandatory. Taxpayers can’t get out of them. For advocates of the deduction, eliminating it would therefore constitute double taxation.
At the same time, the SALT deduction is one of the largest federal tax expenditures. Along with the mortgage interest deduction, the non-taxation of employer-sponsored health benefits and pension benefits, preferential tax rates on capital gains and the tax deferral of corporate profits earned abroad, the SALT deduction costs the federal government trillions in missed revenue opportunities. In fact, the Congressional Budget Office expects that those and other tax expenditures will add up to over 8% of GDP in 2017. That’s an amount equal to nearly half of all federal revenues projected 2017.
So who will miss the SALT deduction the most? According to a 2016 report from the Tax Policy Center, “Taxpayers with incomes over $100,000 would have the largest tax increases both in dollars and as a percentage of income.” Eliminating the deduction entirely would raise taxes for about a quarter of taxpayers and reducing the deduction (as Congress is planning to do) would affect about half as of people.
Filers with incomes over $500,000 would be greatly affected, but their loss in deductions would also be offset by the decrease of the top income tax rate (from 39.6% to 37%), the doubling of the estate tax deduction and cutting the capital gains rate from 23.8% to 21%.
Lower-income individuals would feel less direct impact from reducing the SALT deduction, but they would still be affected indirectly. That same report from the Tax Policy Center found that changing the SALT deduction could lead to a change in revenue for local and state governments. In response to the fact that people are paying more in federal taxes, those governments could choose to decrease their local tax rates. This would leave them with less to spend on government-sponsored programs and services.
The Reduced State and Local Tax Deduction
President Trump’s original tax plan called for eliminating the deduction for state and local taxes. In fact, almost all itemized deductions were slated to disappear. This would raise revenue to (partially) offset the revenue lost as rates on personal and business taxes are slashed.
As Congressional lawmakers debated tax reform, they agreed to only reduce the SALT deduction. The final tax bill that President Trump signed into law allows filers to deduct up to $10,000 in state and local property and income taxes.
How the Reduced State and Local Tax Deduction Will Affect Taxpayers
New York, Connecticut, New Jersey, California, Massachusetts, Illinois, Maryland, Rhode Island and Vermont are the states (plus the District of Columbia) with the highest average deduction for state and local taxes. Here’s how those deductions break down:
- How Reduced Deductions for State and Local Taxes Will Affect New York Taxpayers
Residents of New York take the highest average deduction for state and local taxes, according to IRS data. In 2014, 34.14% of New York tax returns included a deduction for state and local taxes. The average size of those New York SALT deductions was $21,038.02.
- How Reduced Deductions for State and Local Taxes Will Affect Connecticut Taxpayers
Connecticut residents take the second-highest average deduction for state and local taxes. 41.04% of Connecticut returns included a SALT deduction in 2014. The average size of Connecticut deductions for state and local taxes was $18,939.72.
- How Reduced Deductions for State and Local Taxes Will Affect New Jersey Taxpayers
New Jersey residents pay famously high income and property taxes. It’s no surprise, then, that 41% of New Jersey tax returns claimed a deduction for state and local taxes. The average amount of that deduction was $17,183.33.
- How Reduced Deductions for State and Local Taxes Will Affect California Taxpayers
In 2014, 33.86% of California returns included a deduction for state and local taxes. The average California SALT deduction was $17,148.35.
- How Reduced Deductions for State and Local Taxes Will Affect D.C. Taxpayers
Because D.C. homes are so expensive, residents tend to pay a lot in property taxes. Income taxes in the District are high, too. It’s not surprising, therefore, that 39.19% of D.C. tax returns included deductions for state and local taxes. The average size of those deductions was $15,452.40.
- How Reduced Deductions for State and Local Taxes Will Affect Massachusetts Taxpayers
36.73% of Massachusetts returns took deductions for state and local taxes. The average size of Massachusetts SALT deductions was $14,760.99.
- How Reduced Deductions for State and Local Taxes Will Affect Illinois Taxpayers
32.34% of Illinois returns deducted state and local taxes paid in 2014. The average SALT deduction on those Illinois returns was $12,877.51.
- How Reduced Deductions for State and Local Taxes Will Affect Maryland Taxpayers
A whopping 45.04% of Maryland tax returns included a deduction for state and local taxes in 2014. That’s the highest percentage of returns claiming SALT deductions of any state. The average size of those deductions was $12,442.78.
- How Reduced Deductions for State and Local Taxes Will Affect Rhode Island Taxpayers
Although Rhode Island is a small state, its residents tend to have big incomes and big property tax bills. As a result, 32.83% of Rhode Island tax returns deducted state and local tax payments. The average size of Rhode Island SALT deductions was $12,138.75.
- How Reduced Deductions for State and Local Taxes Will Affect Vermont Taxpayers
Finally, rounding out our list of the top 10 states with the highest average deduction for state and local taxes is Vermont, where 27.41% of returns took SALT deductions. The average size of state and local tax deductions in Vermont was $11,843.95.
|THE STATES WITH THE HIGHEST AVERAGE DEDUCTION FOR STATE AND LOCAL TAXES|
|State||Percent of Filers Who Deduct State and Local Taxes||Average Size of Deduction for State and Local Taxes|
Is President Trump’s plan to reduce the deduction for state and local taxes just a rich person problem? Yes and no. It’s probably more accurate to say it’s a rich-person-in-a-blue-state problem. Residents of high-tax California, D.C., Massachusetts, Illinois, Maryland, Connecticut, New York and New Jersey would be the filers most impacted. Middle class Americans who currently itemize will also face higher taxes as a result of reducing the SALT deduction.
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