State and local taxes (SALT) have long been a valuable tool for taxpayers seeking to lower their federal tax burden. Prior to 2018, taxpayers could deduct the full amount of their state and local income, sales, and property taxes from their federal taxable income without a limit. This deduction was especially useful in states with higher tax rates and property values, providing meaningful relief and incentivizing homeownership and local investment.
Key Modifications Introduced by Tax Reform
The Tax Cuts and Jobs Act, enacted in December 2017 and effective beginning in the 2018 tax year, introduced significant reforms that changed the landscape for SALT deductions. One of the most impactful changes was the implementation of a $10,000 cap on the total deduction for state and local taxes. This limit applies to the combined total of income, sales, and property taxes paid during the tax year.
For individuals filing separately, the maximum deduction allowed is $5,000. This cap remains in place regardless of the taxpayer’s actual tax payments, which means any amount above these thresholds cannot be deducted. The limit significantly affects taxpayers in high-tax states, altering strategies for maximizing deductions and affecting overall tax liability.
Rise of the Standard Deduction
To balance the limitation on itemized deductions like SALT, the tax reform legislation significantly increased the standard deduction. For the 2018 tax year, the standard deduction rose to $12,000 for single filers and $24,000 for married couples filing jointly. This change shifted the dynamic for many taxpayers who previously itemized deductions, as they now find the standard deduction more advantageous.
With the standard deduction nearly doubling, many individuals no longer need to itemize their deductions, which in turn makes the capped SALT deduction less relevant for them. However, for those with itemized deductions that still exceed the standard threshold, understanding how to best utilize the SALT deduction within the new limits remains essential.
Itemizing vs. Taking the Standard Deduction
Each taxpayer must now make a more deliberate decision between itemizing deductions and claiming the standard deduction. The decision largely depends on the total of all allowable itemized deductions, including mortgage interest, charitable donations, and medical expenses, in addition to SALT.
For taxpayers whose itemized deductions surpass the standard deduction, itemizing may still provide a larger tax benefit. However, for many, especially those without a mortgage or significant charitable contributions, the increased standard deduction makes it the preferable option.
Choosing Between Income Tax and Sales Tax
Under the current rules, taxpayers are still required to choose between deducting state and local income taxes or state and local sales taxes. This rule predates the tax reform and continues to apply under the new legislation. Taxpayers in states with no income tax, such as Texas or Florida, often benefit more from deducting sales taxes.
The Internal Revenue Service provides optional sales tax tables to help taxpayers estimate their allowable deduction, though actual receipts can be used if they result in a higher deduction. Large purchases such as vehicles or home renovations can increase the deductible amount for sales tax, making it a valuable option in the right circumstances.
Geographic Impact: High-Tax vs. Low-Tax States
The SALT deduction cap has created a noticeable divide between taxpayers in high-tax and low-tax states. States like New York, California, New Jersey, and Connecticut, known for high property values and income tax rates, are particularly affected by the $10,000 cap.
Previously, residents in these states could deduct their full property and income tax payments, significantly reducing their federal tax bill. Now, many find themselves unable to deduct a large portion of those payments, leading to higher overall federal tax liabilities. This shift has prompted some residents to reconsider their financial decisions and even their residency.
In contrast, residents of low-tax states may experience little to no impact from the deduction cap, particularly if their total state and local tax burden already falls below the $10,000 limit. For these taxpayers, the increased standard deduction may further enhance their tax position.
Influence on Real Estate and Homeownership Decisions
The limitation on SALT deductions has implications beyond income taxes. One significant area of impact is the housing market, particularly in areas with high property taxes. The ability to deduct property taxes has historically been a key incentive for homeownership. With the deduction now capped, that incentive is diminished, especially for homes with high annual property tax bills.
This change could affect property values and buyer behavior in certain regions. Potential buyers may be less willing to purchase homes in areas with high taxes, knowing they won’t be able to deduct the full amount. In turn, this could place downward pressure on home prices in affected markets.
Vacation Homes and Secondary Properties
The tax treatment of vacation homes also saw changes under the new SALT deduction rules. Whether or not property taxes on a second home can be fully deducted depends on how the property is used throughout the year.
If a vacation home is used strictly for personal purposes or rented out for fewer than 15 days in a year, the real estate taxes paid on it can be included in the itemized deduction for SALT. However, this amount is still subject to the $10,000 cap across all properties.
If the property is rented out for 15 or more days during the year, and the rental income is reported on Schedule E, then the portion of the property taxes allocated to rental use can be deducted as a business expense. This business deduction is not subject to the $10,000 SALT cap, providing a potential workaround for those who use their vacation properties as income-generating assets.
Business-Related Property and State Taxes
One important exception to the SALT cap applies to state and local taxes related to business activities. Taxes paid on properties used in a trade or business, or held for investment purposes, are not included in the $10,000 limit.
For example, real estate taxes paid on a rental property reported on Schedule E, or business properties reported on Schedules C or F, are fully deductible as business expenses. These deductions are not limited and do not impact the amount that can be deducted on Schedule A for personal SALT expenses. This exception allows business owners and investors to continue deducting the full amount of state and local taxes incurred in the course of business, preserving a valuable tax benefit.
Filing Status Considerations
The SALT deduction cap applies across different filing statuses but impacts them in slightly different ways. Single filers and married couples filing jointly are allowed up to $10,000 in SALT deductions. However, married individuals filing separately are limited to $5,000 each.
This difference can complicate tax planning for married couples, especially when their state and local tax burdens exceed the cap. In many cases, filing jointly will still result in a more favorable tax outcome, but couples with unique financial circumstances may benefit from evaluating both filing statuses to determine the most advantageous approach.
Planning Strategies Moving Forward
Taxpayers affected by the SALT deduction cap may need to consider alternative planning strategies. This might include shifting charitable contributions to increase itemized deductions, bunching deductions into a single year, or investing in assets that provide deductible expenses outside the SALT limit.
Additionally, taxpayers with rental or business properties may explore ways to allocate more expenses to business use, allowing them to take advantage of uncapped deductions on other schedules. Consulting with a financial advisor or tax professional can help identify personalized strategies that align with individual circumstances and long-term financial goals.
Changes and Their Effects
The 2018 tax reform brought sweeping changes to the way state and local taxes are handled on federal returns. While the deduction still exists, it is now subject to significant limitations that affect both individuals and the broader economic landscape. Taxpayers must now navigate a more complex environment, weighing the benefits of itemizing against an expanded standard deduction and finding new ways to manage their tax liabilities within the revised framework.
Understanding Exceptions to the SALT Deduction Cap
While the $10,000 SALT deduction cap imposed by the 2018 tax reform limits deductions on personal state and local taxes, there are important exceptions that allow some taxpayers to work around this ceiling. These exceptions mostly apply to business-related deductions and specific ownership structures that separate personal and business finances.
One notable exception is that property taxes and other local taxes paid on business or investment properties are not subject to the cap. This includes income-producing real estate, farms, and sole proprietorships. Because these taxes are categorized as business expenses, they are deductible on Schedules C, E, or F, outside of Schedule A where the SALT cap applies.
Using Pass-Through Entities and Business Structures
Some taxpayers have explored the possibility of using pass-through entities such as S-corporations, partnerships, and limited liability companies (LLCs) to deduct state and local taxes at the business level. Several states have enacted entity-level taxes that allow these business entities to pay the state tax, with owners receiving a credit on their individual returns.
This workaround has been accepted by the IRS in certain situations, giving business owners a legal method to bypass the individual SALT deduction cap. The rules for these pass-through entity taxes vary by state, so careful consideration and compliance with local regulations are essential before pursuing this strategy.
Real Estate Investors and SALT Deductions
Real estate investors stand to benefit significantly from the exceptions to the SALT cap. Since rental properties generate income and are typically held for investment purposes, the associated taxes qualify as business deductions.
Investors can deduct property taxes, local assessments, and certain fees without worrying about the $10,000 limit, provided those costs are reported on Schedule E. This treatment enables real estate professionals and landlords to maintain their full deduction benefits even under the new tax rules.
Additionally, investors can explore cost segregation studies and depreciation strategies to further enhance their deductions. By accelerating depreciation, investors may reduce taxable income even more, creating additional tax savings beyond those from property taxes alone.
Business Owners and Schedule C Deductions
For sole proprietors or small business owners who operate under Schedule C, state and local taxes directly related to the business remain fully deductible. This includes local business license fees, state gross receipts taxes, and tangible personal property taxes on business equipment.
These deductible business expenses help lower taxable income and are not restricted by the $10,000 SALT cap that applies to personal deductions on Schedule A. Business owners can also evaluate their expenses to identify additional taxes that might be allocated to business use, ensuring maximum allowable deductions.
Planning Strategies for High-Income Taxpayers
High-income earners, particularly those in high-tax states, are among the most affected by the SALT deduction limitation. However, several planning strategies can help mitigate the financial impact.
One such strategy involves bunching deductions, or timing deductible expenses so they occur in a single tax year. For example, by prepaying property taxes or making multiple years’ worth of charitable donations in one year, taxpayers may increase their total itemized deductions above the standard deduction, making it worthwhile to itemize.
Another option is to invest in donor-advised funds (DAFs), which allow donors to contribute a large amount in one year, take the full charitable deduction, and distribute the funds to charities over time. This approach can help offset the loss of SALT deductions with enhanced charitable deductions.
Charitable Contributions as a Strategic Offset
Charitable giving has long been a favored deduction for taxpayers looking to reduce taxable income. Under the new tax rules, with many itemized deductions capped or eliminated, charitable donations have become even more valuable as one of the remaining uncapped itemized deductions.
Taxpayers who find themselves limited by the SALT deduction can consider increasing their charitable contributions to boost their itemized totals. Strategies such as donating appreciated assets like stocks or mutual funds can offer additional tax benefits by avoiding capital gains taxes. In combination with bunching strategies or DAFs, charitable giving can be a key part of managing overall tax liability while maintaining alignment with philanthropic goals.
Considering Alternative Minimum Tax Implications
Prior to 2018, one of the concerns with SALT deductions was their potential to trigger the Alternative Minimum Tax (AMT). SALT deductions were not allowed under AMT, so taxpayers with high deductions sometimes found themselves subject to this parallel tax calculation.
The 2018 reform raised the AMT exemption amounts and phase-out thresholds, meaning fewer taxpayers are subject to it. However, those who are still liable for AMT may find that their SALT deductions provide limited benefit. Understanding one’s potential AMT exposure is crucial when deciding how to allocate deductions and optimize tax outcomes.
Tax Considerations for Moving or Changing Residency
The limitation on SALT deductions has prompted some taxpayers to consider relocating to lower-tax states. The financial impact of the deduction cap, when combined with high state income and property taxes, can significantly increase the overall cost of living in certain regions.
Changing residency can reduce state tax obligations, especially for retirees and remote workers who have flexibility in choosing where to live. However, changing state residency for tax purposes requires careful planning and documentation to avoid audit risk and ensure compliance with state tax laws.
Factors that determine state residency include time spent in the state, location of the primary home, voter registration, driver’s license, and where income is earned. Each state has its own rules for determining residency, so professional guidance is recommended.
Potential Legislative Changes on the Horizon
Since the implementation of the SALT deduction cap, there have been multiple discussions and proposals aimed at modifying or eliminating it. Lawmakers from high-tax states have argued that the cap unfairly penalizes their constituents and have introduced legislation seeking to restore full deductibility.
While various bills have been introduced in Congress to repeal or raise the SALT cap, none have passed both chambers as of now. The outcome depends on political dynamics, budget priorities, and broader tax policy negotiations. Taxpayers should stay informed of legislative developments that may affect their planning strategies and deductions.
Coordinating with a Tax Professional
Navigating the complexities of the SALT deduction cap and related strategies requires in-depth knowledge of federal and state tax laws. Working with a qualified tax advisor can help identify opportunities to optimize deductions, ensure compliance, and align tax decisions with long-term financial goals.
A tax professional can assist with evaluating filing status options, entity structures, charitable planning, and the impact of investment and business decisions. They can also monitor changes in tax law and suggest timely adjustments to minimize tax liabilities under current and future regulations.
Tax-Efficient Investing and Portfolio Strategies
Investors affected by the SALT cap may also want to review their investment portfolios for tax efficiency. Municipal bonds, particularly those issued by an investor’s home state, offer income that is exempt from federal income taxes and, in some cases, state taxes as well.
Tax-loss harvesting is another strategy to consider. By selling investments at a loss, investors can offset capital gains, reducing overall tax liability. This technique, when executed properly, can provide an effective way to manage taxable income.
Investors should also consider asset location strategies—placing income-generating assets in tax-deferred accounts like IRAs or 401(k)s, while holding growth-oriented investments in taxable accounts—to maximize after-tax returns.
Role of State Programs and Credits
Some states have introduced programs to help residents mitigate the effect of the SALT cap. These include state-level credits for charitable contributions to designated funds, local tax workarounds, and business tax restructuring.
These programs vary widely and are subject to IRS scrutiny. Participation in such programs should be approached with caution, and only after evaluating their legality and financial benefit. In some cases, these initiatives have been challenged or disallowed by federal authorities.
Next Steps for Taxpayers
Understanding the full scope of the SALT deduction cap and available strategies allows taxpayers to make informed decisions that minimize the impact of the limitation. Whether through entity restructuring, charitable giving, or business deductions, there are multiple ways to reduce federal tax liabilities.
State Government Reactions to the SALT Cap
The $10,000 cap on state and local tax deductions introduced a considerable challenge for high-tax states. In response, several states quickly sought legal and legislative remedies to soften the blow for their residents. States like New York, Connecticut, New Jersey, and California led the charge in developing creative workarounds aimed at restoring the tax benefit to their taxpayers.
Many of these efforts involved the creation of state-sponsored charitable funds. Taxpayers could make contributions to these funds and receive a state tax credit in return. These contributions were then claimed as charitable deductions on federal returns, potentially bypassing the SALT cap. However, the IRS issued regulations disallowing this strategy if a state tax credit was received in return for the charitable contribution.
Pass-Through Entity (PTE) Workarounds
In response to IRS rulings on charitable fund workarounds, several states pivoted to an alternative approach using pass-through entities. The pass-through entity tax workaround permits certain businesses like S corporations and partnerships to pay state income taxes at the entity level. This payment is deductible at the federal level and does not count against the owner’s SALT limit.
This workaround has been sanctioned by the IRS under Notice 2020-75, which gave states confidence to enact legislation formalizing such treatment. As of now, more than 30 states have passed laws enabling pass-through entity level taxation. This solution has become a cornerstone of state-level tax planning for small business owners and investors.
Evaluating the Effectiveness of State Workarounds
The effectiveness of these state-level solutions varies by jurisdiction and individual tax situation. While PTE taxes offer real benefits to business owners, they may not assist employees or retirees with no business income. Additionally, rules and eligibility criteria differ from state to state, and not all taxpayers may qualify.
Moreover, taxpayers must weigh the benefits against potential complexity and compliance costs. For example, electing PTE treatment may require additional filings, recalculation of estimated payments, or adjustments to state K-1 forms. Professional guidance is often necessary to determine whether these workarounds provide a net benefit.
Impact on Different Income Groups
The SALT deduction cap has a disproportionate effect across income levels. Middle-income taxpayers may see minimal impact if their total state and local taxes fall under the $10,000 limit. However, high-income earners in expensive real estate markets often exceed the cap, making them more likely to experience a significant increase in federal taxable income.
For example, a homeowner in a suburban area with a $15,000 property tax bill and $10,000 in state income taxes can only deduct $10,000 total, leaving $15,000 of paid taxes non-deductible. This loss of deductibility can translate to thousands of dollars in higher federal taxes.
Meanwhile, taxpayers in low-tax states or those who rent instead of own may experience little or no change to their federal liability under the cap. The unequal impact has sparked debate about fairness and has added pressure on policymakers to reevaluate the cap’s long-term viability.
Regional Real Estate Market Effects
The cap on SALT deductions has also had noticeable implications in the real estate markets of high-tax states. Potential homebuyers in expensive regions are more cautious, knowing they may not be able to deduct the full cost of property taxes.
In some cases, property values have softened as buyers reassess what they can afford. High-end markets, in particular, have seen reduced activity, as the carrying costs of ownership become less tax-efficient. Real estate agents and financial planners in these areas now regularly include tax analysis in the home buying process.
Developers and builders may also adjust project plans to align with buyer demand for more tax-efficient properties. This could mean smaller homes or communities with lower tax rates becoming more attractive than luxury developments with high annual tax bills.
Case Examples of SALT Cap in Practice
Let’s explore a few practical scenarios to illustrate how different taxpayers are affected:
Case 1: A High-Income Executive in New Jersey Jane earns $400,000 per year and owns a home in New Jersey where she pays $18,000 in property taxes and $22,000 in state income taxes. Under the SALT cap, she can only deduct $10,000 total. Despite paying $40,000 in state and local taxes, she loses the ability to deduct $30,000.
Case 2: A Small Business Owner in California Using a PTE Michael owns a business that earns $300,000 annually. California offers a PTE election, which he opts into. The business pays $30,000 in state tax at the entity level, which is fully deductible for federal purposes. Michael avoids the SALT cap personally and preserves a significant deduction.
Case 3: A Retired Couple in Florida Jack and Linda are retirees with $80,000 in annual income and no state income tax liability due to living in Florida. Their property taxes are $6,000. Because they do not exceed the SALT cap, their itemized deductions are not affected. However, they likely take the standard deduction anyway due to limited other itemized deductions.
Strategies for Tax Year Planning
Taxpayers impacted by the SALT deduction limitation can consider a number of annual planning tactics to minimize liability:
- Review year-end bonus payments and timing of income to manage income tax exposure
- Time property tax payments in a way that aligns with deduction planning goals
- Coordinate charitable giving in years where SALT deduction losses are highest
- Explore business expense reclassification for home office and mixed-use assets
These proactive strategies can improve overall tax positioning while maintaining compliance with evolving tax laws.
Comparing SALT Cap Impacts on Filing Status
Filing status plays a critical role in determining how the SALT cap affects a household. Married couples filing jointly share a $10,000 cap, while those filing separately each get a $5,000 limit.
This can lead to complex decisions. For couples with substantial state and local tax bills, filing separately might seem like a way to double the deduction. However, other tax code provisions often penalize separate filers with reduced credits or limitations on deductions, potentially making this approach less effective overall.
The choice of filing status should always be made after running comparative calculations, accounting for not just SALT deductions, but all available credits and benefits across both scenarios.
Technology Tools and Tax Software Enhancements
Modern tax preparation tools and professional software platforms have incorporated SALT cap diagnostics into their functionality. These systems flag when taxpayers hit the deduction ceiling and provide suggestions for optimizing tax outcomes.
For individual filers, this means better visibility into how much of their state and local taxes are being disallowed and whether itemizing still makes sense. Some platforms also incorporate state-specific PTE election prompts, helping users make better-informed decisions.
Financial professionals increasingly rely on these tools to conduct multi-year scenario planning, which helps clients prepare for high-liability years or changes in residency. The digital evolution of tax planning makes it easier to adapt quickly to regulatory shifts and assess strategies with precision.
Monitoring IRS Guidance and Legal Rulings
As with any significant tax change, the SALT deduction cap has been the subject of extensive IRS guidance and ongoing legal review. Regulations issued by the IRS have clarified many questions, including the denial of state charitable fund workarounds and the acceptance of entity-level tax deductions.
It is essential for taxpayers and advisors to stay updated on new rulings, especially as states test the boundaries of what the IRS will allow. While the basic structure of the cap remains intact, subtle interpretations or updates can influence compliance and planning.
Pending legislation or legal challenges in federal courts may eventually alter or reverse some of the current restrictions. Taxpayers affected by the cap should remain engaged with news from trusted tax authorities or professional advisors.
State-Level Ballot Measures and Reform Efforts
In addition to federal initiatives, some states have proposed local ballot measures to restructure their tax systems in light of federal deduction limits. These include efforts to lower state income taxes, increase homestead exemptions, or provide direct tax relief to residents unable to deduct full SALT amounts.
Such reforms often require voter approval and may take several years to implement. Nevertheless, they signal ongoing efforts at the state level to address the uneven burden created by the federal SALT cap. Advocacy groups and political leaders continue to push for solutions tailored to regional economic realities.
Looking Ahead: Long-Term Considerations
The SALT deduction cap is currently set to expire after 2025, along with other provisions from the 2017 tax reform law. Whether the cap will be extended, modified, or eliminated depends on future congressional action.
Taxpayers should plan based on current law while remaining flexible. Mid- to long-term tax strategies may need to be reevaluated if significant reforms are passed. In the meantime, focusing on legal and proven strategies remains the best course of action for minimizing exposure to the SALT limitation.
Conclusion
The changes to the state and local tax deduction introduced by the 2018 tax reform significantly reshaped how taxpayers calculate and claim their itemized deductions. With the implementation of a $10,000 cap on SALT deductions, many individuals, especially those in high-tax states, found their deductions reduced. However, understanding the nuances of the new rules helps taxpayers make informed choices when filing.
While the standard deduction increase has simplified the process for many, those who still benefit from itemizing must carefully assess which taxes they can deduct and how to allocate them. Business-related taxes and rental property expenses remain outside the SALT cap, offering some relief for those with income-generating assets. Additionally, the way vacation homes and mixed-use properties are treated under the deduction limit highlights the importance of clear recordkeeping and understanding property usage.
For taxpayers navigating these changes, the key takeaway is that the SALT deduction is not eliminated, it is simply restructured. Taking the time to evaluate your filing status, total itemized deductions, and applicable business expenses can help ensure you take full advantage of available benefits under the revised tax law. Staying informed and consulting a knowledgeable tax advisor when needed can make a significant difference in minimizing your tax liability and avoiding costly errors.