What is the SALT (national and local tax)?
The acronym SALT stands for State and Local Tax and is commonly associated with the Federal Income Tax Deduction for State and Local Taxes available to taxpayers who itemize their deductions. In 2017, a $10,000 cap on the previously unlimited SALT deduction was adopted and made applicable for tax years beginning in 2018 and continuing through 2025.
Limiting the deduction has sparked ongoing political debate, with high-income individuals and officials in high-tax states leading intense opposition.
Understanding SALT: Which local and state taxes are deductible?
Individual taxpayers who itemize their personal deductions can deduct up to $10,000 of their aggregate state and local taxes per annual return ($5,000 for those married separately). The limitation does not apply to taxes paid or accrued in the exercise of a trade or business or incurred as an expense in an income-generating activity.
Deductible taxes include state, local, and foreign income taxes, war profits, and excess profits; and state and local (but not foreign) taxes on personal and real property, including amounts paid by tenant-shareholders to co-operative housing societies as such corporations’ property taxes. Taxpayers may choose to deduct state and local general sales taxes instead of claiming an income tax deduction. Deductible state and local sales taxes include retail sales taxes, similar “compensatory use” taxes for the use, storage, or consumption of items, and motor vehicle taxes.
Taxes imposed on certain distributions of income related to generation-skip transfers by trusts and estates are also deductible if the distribution is included in the taxpayer’s income.
Impact on Federal Revenues
Opponents of limiting the SALT deduction face a significant problem: the impact of the limit on federal revenue. The $10,000 limit on SALT deductions has a significant and measurable revenue impact affecting the federal budget.
Before the limit was passed, the cost of lost revenue to the federal government for the SALT deduction was estimated to be $78 billion and $82 billion in fiscal years 2019 and 2020, respectively. After the limit went into effect, the SALT cost of lost federal revenue was lowered to approximately $56.5 billion for fiscal year 2019 and $58.9 billion for fiscal year 2020, which has resulted in a $44.6 billion revenue “saving” in just two fiscal years. Any increase in the cap, and especially its repeal, would decrease federal revenues.
Efforts to mitigate or eliminate the SEL ceiling
Shortly after the passage of the SALT tax deduction cap, a change that hit high-income state taxpayers and property taxes particularly hard, efforts began to reinstate the previous unlimited deduction.
Requalification as a charitable contribution
States responded quickly to the cap on SALT deductions and took various steps to reduce its federal tax cost to their citizens and the negative political environment it created for state and local taxation. Initial efforts by several states to allow their residents to contribute to a state charitable fund instead of paying income taxes were thwarted by final regulations issued by the United States. Treasury Department to cancel this approach.
Dispute
Connecticut, Maryland, New Jersey and New York filed a lawsuit challenging the SALT cap as unconstitutional. The case was dismissed by a federal district court, and in 2021 the United States Supreme Court also ruled against the states.
Special relief for crossings
Owners of intermediate entities (also called flow-through entities) — primarily partnerships and S corporations—received indirect relief from the SALT ceiling in Internal Revenue Service (IRS) Notice 2020-75, published November 9, 2020. The notice stated that upcoming regulations would allow partnerships and S corporations to claim entity-level SALT deductions without applying the SALT cap. This will allow income to flow to partners and shareholders after tax, without having to consider their share of SALT deductions previously claimed by the entity, to determine the SALT limit for their tax returns.
Legislative repeal
Repeal would be the only clearly effective method of eliminating the SALT cap, but its prospects are uncertain. Although some members of both parties support repeal, most supporters are Democrats representing states with higher state and local taxes. Republicans — who more often represent low-tax states — generally do not support repeal.
In November 2019, the United States House of Representatives passed a partial repeal of the SALT cap by a vote of 218 to 206, with five Republicans voting for the bill and 16 Democrats – mostly progressives who considered it inadequate – voting against. The bill would have raised the limit to $20,000 for joint filings for 2019 and eliminated it for 2020 and 2021 for taxpayers with incomes below $100 million. This would have left the $10,000 cap in place for 2023 to 2025.
In early 2021, bills to eliminate the SALT cap were introduced in both houses of Congress. In the House of Representatives, the proposed legislation already had more than 106 co-sponsors before March. In the Senate, Majority Leader Sen. Charles Schumer, DN.Y., introduced a total repeal bill, while Sen. Susan Collins, R-Maine, introduced legislation to increase the limit $20,000 for joint filings.
Because the current law on the SALT deduction cap expires after December 31, 2025, the SALT cap will disappear in 2026 unless it is extended by legislation in the meantime.