State and local governments generally charge some type of taxes on their citizens in the form of property taxes, sales taxes, or state income taxes. Traditionally, those who paid these taxes were eligible to deduct the amount of their payment from their income on the federal level. The deduction of state and local taxes is abbreviated as the SALT deduction, and it's available to those who itemize on their federal tax returns.
In 2017, however, the Tax Cuts and Jobs Act passed and reformed federal tax law. One of the biggest changes was a limitation on the SALT deduction, which went into effect in 2018. This change made it so that itemizing no longer makes sense for many -- and it also caused millions of Americans to lose a substantial portion of their deductions.
Here's how it works.
There's now a cap on your SALT deduction
The Tax Cuts and Jobs Act imposed a $10,000 limit on the SALT deduction, so regardless of how much you actually pay in state and local taxes, you're only allowed to deduct a maximum of $10,000 of that amount from your federal taxable income. The taxes covered by the SALT deduction include:
- State income or sales taxes (you can deduct either income taxes or sales taxes, but not both in the same year)
- Real estate taxes
- Personal property taxes
This $10,000 cap applies to all tax filers regardless of their filing status, except for married filing separately. Separate filers face a $5,000 SALT cap.
Here's how this could affect you. Say you have $125,000 in adjusted gross income and $25,000 in other deductions you're entitled to itemize, and your total bill for property tax and state income tax is $24,000. Under the old rules, you would be able to take a $24,000 SALT deduction. Your taxable income reported to the IRS would decline to $76,000.
But under the new rules, while you'll still have to pay the $24,000 in state and local taxes, you won't be able to deduct your entire payment amount. You would only be able to claim $10,000 and would lose $14,000 worth of deductions. Instead of your income coming down from $125,000 to $76,000, it would instead be reduced from $125,000 to $90,000 -- assuming you still itemized on your tax return (more on that below).
Unfortunately, it's difficult to do a head-to-head comparison of how much the loss of your SALT deductions would cost you if you still itemize because the Tax Cuts and Jobs Act also changed the tax brackets. However, a 2019 Inspector General Report found that if the $10,000 cap had been imposed in tax year 2017 before other changes to the tax law occurred, it would have reduced the amount of the SALT deduction for 10.9 million taxpayers, who collectively would've seen the value of their deductions fall by $323 billion.
Should you still itemize? The SALT cap could change the math
Assessing the impact of the SALT limitation is a challenge because the Tax Cuts and Jobs Act also made another big change. It more than doubled the standard deduction. As a result, you may find that while it once made sense to itemize on your taxes, it no longer does. And if you don't itemize any more, the SALT cap won't impact you.
In 2021, the standard deduction is $12,550 for individuals and married couples filing separately, $18,800 for heads of household, and $25,100 for married joint filers. In other words, it's more than the SALT deduction could possibly be worth with the new limit imposed.
If the $10,000 you're still allowed to deduct for state and local taxes combines with your other deductions so the total amount is over $12,550, $18,800, or $25,100, you should still itemize on your taxes. In this case, if your state and local taxes cost more than $10,000, you're losing out on deductions you could've claimed had the SALT limit not been in place. But if you don't have many other deductions, the $10,000 you're now allowed to claim would be below the standard deduction so itemizing wouldn't make sense any more.
The SALT cap has been the law for years and will remain in effect until 2025 when the limitation ends unless tax laws change before then. As long as it's in force, millions of Americans are going to be taxed at the federal level on money they've used to pay other taxes locally.