Tax planning for the SALT cap
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The Tax Cuts and Jobs Act (TCJA), P.L. 115-97, limited itemizers’ state and local tax (SALT) deductions to $10,000 for tax years 2018 through 2025 (the SALT cap). However, federal policymakers have continued to battle each other and state policymakers over the limit. Although increasing the limit and extending its time frame were part of the Build Back Better Act, H.R. 5376, passed by the House in November 2021, the final version signed into law in August 2022, the Inflation Reduction Act of 2022, P.L. 117-169, included no SALT limit changes. While some lawmakers want complete repeal of the provision, others want to extend it past 2025. With the 2025 sunset getting closer, lawmakers will no doubt continue to raise the issue, and it will remain divisive.

Amid this uncertain prospect, taxpayers will be looking to their CPA tax advisers for guidance on how to plan for the cap’s sunset or possible extension, with an eye toward maximizing their deductions under the cap for the 2024 and 2025 tax years. The discussion that follows outlines the possibilities and some sensible approaches.

BACKGROUND AND SIGNIFICANCE OF THE SALT CAP

Before the TCJA was enacted, individual taxpayers could deduct their SALT amounts as itemized deductions with no limitations. Secs. 164(a)(1), (2), and (3) allow deductions for real property taxes (foreign, state, and local); personal property taxes (state and local); and income taxes (foreign, state, and local), respectively, paid or accrued during the tax year. Under Sec. 164(b)(5), taxpayers can choose to deduct state and local sales taxes paid in lieu of state and local income taxes.

The TCJA imposed a $10,000 limit ($5,000 for a married-filing-separately return) on SALT deductions for tax years beginning in 2018 through 2025 (Sec. 164(b)(6)(B)) and excluded foreign real property taxes from the allowable deduction (Sec. 164(b)(6)(A)).

It is important to note that the TCJA also essentially doubled the standard deduction, substantially reducing the number of people who itemize and, therefore, the number of people to whom the SALT cap would apply. In fact, the authors’ calculations show that the percentage of itemizers in the United States went from 31% in 2017 to 11% in 2018. Nevertheless, the IRS’s Statistics of Income (SOI) data from 2017–2018 helps to reveal, at least in part, who was affected by the SALT cap and to provide valuable insights for CPAs regarding which states and taxpayers are most affected and where opportunities may arise for tax planning purposes among various clients.

The authors calculated the percentage decrease in the average SALT deduction from 2017 (when the SALT cap did not apply) to 2018. This analysis focuses only on those taxpayers who took the SALT deduction, so, to the extent the standard deduction increased under the TCJA to outweigh a taxpayer’s itemized deductions, these previous itemizers would be excluded from the 2018 numbers. The table “Decrease in Average SALT Deduction” is sorted by the largest percentage decrease. New York, California, and Connecticut had the top three largest decreases in the average SALT deduction at 64.33%, 59.63%, and 58. 76%, respectively. For these states, as well as the District of Columbia, New Jersey, and Massachusetts, the average SALT deduction was reduced by more than half between 2017 and 2018. Perhaps even more striking is that almost every state (all but eight) experienced a decrease of 20% or more, highlighting how valuable the SALT deduction is and how significant the SALT burden can be.

Perhaps a better analysis is shown in the map “Average Amount of SALT Disallowed Per Taxpayer Claiming SALT Deduction, 2018,” which highlights states in dark blue where taxpayers had the highest average disallowance (taken from the 2018 SOI data, Form 1040, Schedule A, Itemized Deductions, line 5a (state and local taxes or general sales taxes) + line 5b (state and local real estate taxes) + line 5c (state and local personal property taxes) – line 5e (smaller of total or $10,000 ($5,000 if married filing separately), times 1,000 and then divided by the number of returns that report any number on line 5e). The highest disallowed SALT deductions occurred in New York, Connecticut, and California. Recently, the Tax Foundation ranked states by their tax burden, measured as state and local taxes paid divided by the state’s share of the net national product. Consistent with our findings regarding SALT disallowances, New York and Connecticut ranked as the highest and second-highest states, respectively, for state tax burdens.

TAX PLANNING OPPORTUNITIES

Nevertheless, tax planning opportunities remain for CPAs and other tax advisers consulting with taxpayers who still itemize. These opportunities include bunching itemized deductions, using state and local credit exchange programs, utilizing a state’s passthrough entity–level tax (PTET), and/or encouraging remote work in lower-taxed states.

Bunching itemized deductions

First, the typical advice of bunching itemized deductions, particularly the non-SALT deductions, into certain tax years remains good advice for those taxpayers who may have specific years where the SALT limit prevents them from itemizing in the first place. For example, if a cashbasis taxpayer has some ability to control when they pay for medical expenses, particularly when these expenses are incurred near the end of the year, he or she could consider waiting until the next tax year to pay them to bunch itemized deductions together into the same tax year (paying the expenses in one year could also help the taxpayer overcome the medical expense threshold of 7.5% of adjusted gross income).

State tax credit or deduction for charitable contributions

Second, as noted in this 2018 Journal of Accountancy podcast, states have adapted to the SALT limit in several creative ways to mitigate the decreased federal tax savings on state and local taxes paid. For example, the second column of the table “State Workarounds to the SALT Cap,” which summarizes data from the U.S. Charitable Gift Trust, shows that 32 states and the District of Columbia offer programs whereby individual taxpayers can receive a state tax credit or deduction in exchange for donating to certain charities or state government organizations. The taxpayer also deducts the donation as a charitable contribution for federal tax purposes, assuming the organization qualifies, and subject to the following caveats.

Although Regs. Sec. 1.170A-1(h) (3) (i) requires taxpayers to reduce their charitable contribution deduction by any benefits received or expected to be received in exchange for the donation (including state tax credits), it makes two exceptions. First, taxpayers do not have to reduce their federal charitable contribution deduction for credits received from the state if the dollar amount of the credits received or expected to be received is no more than 15% of a donation of cash or 15% of the fair market value (FMV) of a donation of property (Regs. Sec. 1.170A-1(h) (3) (vi)). Second, a charitable contribution deduction does not have to be reduced by state or local tax deductions if the amount of the deductions received or expected to be received does not exceed the amount of a donation of cash or the FMV of a donation of property (Regs. Sec. 1. 170A-1(h)(3)(ii)(A)). Although the regulations reduce the potential benefits of using these types of state programs, clients in these specific scenarios will continue to be able to use such programs and take the associated charitable contribution deduction.

For example, an individual makes a $10,000 cash donation to a qualified charity. In return for the cash donation, the individual receives a state tax credit of 75% of the $10,000 cash donation (expected state tax credit of $7,500). In this case, the federal charitable contribution deduction cannot exceed $2,500 ($10,000 donation – $7,500 state tax credit). Interestingly, this reduction applies even if the individual cannot claim the state tax credit in the same tax year.

As a second example where the exception applies, assume an individual donates an antique clock to a qualified charitable organization with an FMV of $50,000 at the time of the donation. In return for the donated clock, the individual expects to receive a state tax credit of 10% of the FMV of the antique clock. The state tax credit amount does not exceed 15% of the FMV of the antique clock. Therefore, the charitable contribution deduction is not reduced and remains $50,000.

Passthrough entity tax

Next, although complicated and an emerging area in state taxation, if individuals subject to the SALT limit are partners or shareholders in a passthrough entity (partnerships and S corporations), it is worth considering locating the entity in a state with a PTET. The basic idea of the PTET is that the passthrough entity elects to pay the state tax. The passthrough entity, because it is a business, is not subject to the SALT limit and can deduct the state tax in full without limitation, resulting in more significant tax savings. The partner or shareholder then, depending on the state statute, generally, either (1) claims a tax credit on their individual state return for their distributive share of the tax paid by the passthrough entity or (2) does not include their distributive share of income from the passthrough entity on their individual state tax return. The PTET column of the table “State Workarounds to the SALT Cap” provides a summary of AICPA data (“States With Enacted or Proposed Pass-Through Entity (PTE) Level Tax,” showing that (as of May 14, 2024) 36 states have enacted a PTET since the TCJA SALT limit was enacted, and one state has proposed a PTET bill). Nine states do not have any personal income tax levied on owners of passthrough entities, which leaves only four states and the District of Columbia that have not at least proposed some form of legislation for a PTET.

The rules of the PTET vary and require in-depth consideration. The following are some of the state-specific areas to consider: Are there owner restrictions? What are the compliance filing requirements? What is the interplay if the entity is operating in multiple states? Should the entity make estimated tax payments? Do the state tax rates differ for individuals vs. passthrough entities? While the PTET may result in tax savings to the individual partners or shareholders, there are multiple tax implications to consider and discuss with a client.

Working remotely

Another interesting aspect of tax planning has arisen thanks to the proliferation of remote and hybrid working environments. Although the number of people working remotely has certainly decreased as the COVID-19 pandemic restrictions have been lifted, many companies have adopted far more flexible work policies than existed before 2020 and have offered these alternatives to continue in order to attract talented workers. Tax advisers working with individual clients who work remotely may need to broaden their geographic scope when considering the various alternatives for their clients’ tax home and taxable activities.

While income can be taxed both in the state where it is earned and in the state where the taxpayer lives, all states with an income tax on wages offer credits for taxes paid to other states. Some states go further and offer reciprocity agreements with other states, which eliminates the need for taxpayers to file in both states and results in the taxpayer owing tax exclusively to the state of residence. Thirty reciprocity agreements are offered across 16 states and the District of Columbia, with each of those states participating in between one and seven agreements (Walczak, “Do Unto Others: The Case for State Income Tax Reciprocity,” Tax Foundation (Nov. 16, 2022)). Taxpayers who work remotely may be able to lower their SALT burden by moving to a lower-tax-rate state that has a reciprocity agreement with the state in which their employer is located. Also, taxpayers may be able to lower their non–income tax SALT by engaging in remote work while living in a state with lower property taxes.

Indeed, state and local taxes represent only one component of the work/life location decision. Still, the relevance of this factor increases when individuals who work remotely are not tied to any specific physical location. In this case, advisers and clients should consider not only the tax burden of the state where the taxpayer plans to work but also the various programs mentioned above to alleviate that burden.

STRATEGIES AMID UNCERTAINTY

While there is uncertainty as to whether the SALT limit will continue past 2025, it is clear that the current SALT limit restricts the amount of itemized deductions for current taxpayers, especially those in states With a high tax burden. To counter these effects, tax advisers can suggest to their clients, particularly those in high-tax-burden states, to bunch their itemized deductions Into a specific year and investigate whether the state offers a tax credit or deduction for donations to specific charities.

Suppose a client is also a partner or shareholder in a passthrough entity. In that case, the taxpayer may also consider locating the entity in a state with a PTET to avoid the SALT limit. Lastly, and probably most challenging to implement, a client may consider relocating to a state with a lower state income tax rate if they can work remotely. In addition to the tax planning opportunities discussed, there is also the strategy of waiting out Congress in hopes that it will let this part of the law sunset without extending it.