State and local tax breaks could be revived, but not without a fight

WASHINGTON, DC – DECEMBER 20: Senate Minority Leader Chuck Schumer (D-NY) listens as Speaker of the House Nancy Pelosi (D-CA) speaks during a press conference on Capitol Hill on December 20, 2020 in Washington, DC. Republicans and Democrats in the Senate finally came to an agreement on the coronavirus relief bill and a vote is expected on Monday. (Photo by Tasos Katopodis/Getty Images)

Tasos Katopodis | Getty Images News | Getty Images

Few issues illustrate the tortured calculus of tax policy in a hyper-partisan political environment better than the state and local tax deductions.

The Tax Cuts and Jobs Act passed by a Republican Congress in 2017 put a $10,000 cap on federal deductions for state and local taxes paid.

There was previously no limit on the deductibility of those taxes.

Republicans argued that the cap was necessary to finance other tax benefits in the bill, including lower personal income tax rates and a lower corporate tax rate.

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The cost of the limitation, however, was shouldered predominantly by high-tax blue states like California and New York.

“The SALT cap was clearly politically motivated,” said Corey Rosenthal, CPA, principal at CohnReznick, specializing in state and local tax issues. “It was the northeast states and California that were hurt the most by it.”

In other words, the blue states.

House Speaker Nancy Pelosi and Senate Majority Leader Chuck Schumer have repeatedly called for repeal of the cap, suggesting it could be one of the first tax policy items Democrats look to change this year.

It could be a bit messy.

“The politics behind the SALT cap are fascinating,” said Jonathan Traub, Washington tax leader for Deloitte Tax LLP.

“Progressives say that full SALT deductibility is a giveaway to the wealthiest of the wealthy, while governors cry about wealthy residents leaving their states and losing their tax base,” he said.

Impact on high-income filers in high-tax regions

The SALT cap has not affected most Americans.

The near doubling of the standard personal deduction to $12,000 under the TCJA and the elimination or reduction of many itemized deductions, including SALT, has resulted in far fewer people filing itemized returns.

The number fell to just 16.7 million in 2018, from 46.2 million in 2017, according to IRS data.  Most middle-class Americans didn’t see their tax bills rise, though many in high-tax blue states did.

“A couple making $200,000 and paying $15,000 in property taxes got banged up a bit,” said Rosenthal of CohnReznick. “We see a lot of middle-class and upper-class people in their mid-50s starting to think about retiring to Florida, Texas or Wyoming.”

It is wealthy people with large real estate holdings and who are also paying lots of state income taxes who have felt the most pain.

The SALT cap was clearly politically motivated. It was the northeast states and California that were hurt the most by it.

Corey Rosenthal, CPA

principal at CohnReznick

Former President Donald Trump, a native of Queens, New York, became a resident of Florida  — which has no personal income tax — in 2019. He claims to have paid millions in New York state and local taxes but has not released his tax returns.

His stated reason for leaving was that he was “treated very badly” by New York politicians.

President Joe Biden, who along with his wife, Jill, reported $944,737 in taxable income for 2019, couldn’t deduct $102,000 of the $112,000 he paid in state, local and real estate taxes.

A repeal of the SALT cap would cost the federal government $673 billion in lost revenue over the next 10 years, according to the Tax Foundation.

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