Tax Strategy: States respond to the SALT deduction limit

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State tax revenues will be impacted in many ways by the federal Tax Cuts and Jobs Act. States vary greatly in the way that their state tax systems coordinate with the federal tax system. Some tie in to federal adjusted gross income. Others tie into taxable income. Some couple to particular provisions of federal law that have been changed by the TCJA. Some offer a state tax deduction for federal income taxes paid. States are looking at a variety of approaches to adjust their state tax systems for the impact of the TCJA.

One of the changes made by the TCJA has been to restrict the deduction for state and local taxes to $10,000 per year. This change will likely have the greatest impact on states with relatively high tax rates and also relatively high-income citizens. Many of these states have been exploring responses to this change — states such as California, Connecticut, Illinois, Maryland, Nebraska, New Jersey, New York, Virginia and Washington.

The primary responses being discussed range from creating an alternative contribution to a state charitable fund or funds to preserve the tax deduction as a charitable contribution, creating a payroll tax deduction for all employees to preserve the tax deduction as a payroll tax, or even suing the federal government for penalizing high-tax states.

In crafting any response to the restriction, it is important to look at who will be impacted by the change. Even before the TCJA was enacted, around two-thirds of taxpayers claimed the standard deduction and had no benefit from the state and local tax deduction. However, in some states the percentage of taxpayers claiming the deduction was much higher, with several states exceeding 40 percent of taxpayers claiming it. In a number of states the average state and local tax deduction claimed has also exceeded $10,000. In 2015, the average state and local tax deduction overall of all taxpayers claiming the deduction with adjusted gross incomes of $100,000 or greater exceeded $10,000.

Of the one-third of taxpayers that have claimed the itemized deduction in the past, it is estimated that half of those will not claim it in the future. This is due to a combination of the increased standard deduction and the reduction in certain of the itemized deductions. To the extent that the itemized deductions claimed in the past did not exceed the new standard deduction, those taxpayers also would not be harmed by the new state and local tax limit. To the extent that the standard deduction is now more attractive because of the reduced itemized deductions, those taxpayers can still be viewed as potentially impacted to some extent by the restriction on the state and local deduction.

Even those taxpayers that, in the past, were eligible for the state and local tax deduction could have faced other hurdles to claiming it. The state and local tax deduction was a preference item totally or partially disallowed if subject to the Alternative Minimum Tax. Also, the Pease phase-out of itemized deductions may have also partially restricted the state and local tax deduction to which a taxpayer may have been entitled.

The net result is that the state and local tax deduction primarily benefited wealthier taxpayers in higher-income states. It is not clear how influential the state and local tax deduction is to these taxpayers in motivating their activities or affecting their possible future actions. Some of the proposed state responses to the restriction of the deduction would primarily be targeted at these wealthier taxpayers; other responses would apply more generally.

A charitable contribution

Over half a dozen states, with California leading the way, are looking at an optional charitable contribution to one or more state charities performing a government function and providing a state income tax credit equal to the charitable contribution. A number of states already offer tax credits for a number of charitable funds with the apparent blessing of the Internal Revenue Service.

Still, there are some concerns with the approach. In general, charitable contributions are supposed to come with charitable intent and no personal benefit to get the charitable deduction. If Congress or the IRS perceived this as an abuse, the deductions could be disallowed and might even be disallowed for existing state tax credits for charities. There is also some concern that too much tax money could be directed to certain programs, exceeding their needs and leaving other responsibilities of state government short of funds. Addressing such issues could add a lot of complexity to these proposals.

By replacing a disallowed itemized deduction with an itemized deduction that is still allowed, a charitable contribution deduction would tend to benefit the same people who had benefited from the state and local tax deduction, i.e., wealthier taxpayers. These proposals could therefore be viewed as tax proposals primarily to benefit the wealthy.

A payroll tax deduction

New York is taking the lead in looking at an expanded payroll tax deduction for employers. The concept is that the payroll tax would be tied to compensation adjustments such that employees after tax would be in the same position that they were before. This could be structured to offset the revenue loss to state taxpayers from the loss of the state and local tax deduction but spread the benefit to a larger group of taxpayers.

This proposal appears to come with a number of complexities that might make it difficult to ensure that the employees are left in the same position that they were in before. Commentators have pointed out issues such as the difficulty in adjusting minimum wages or negotiated wages. It is also possible that, due to the loss of anticipated federal revenue, Congress could also step in to try to curtail this deduction.


New York has also joined with several nearby states to challenge the loss of the deduction in court as being a discriminatory act by Congress. While the state and local tax deduction has been a part of the Tax Code from the beginning, its form has varied, with personal property taxes disallowed and, for a time, state sales taxes disallowed as a deduction. With this precedent, most commentators do not seem to be giving the states much chance of success in this effort.

Congressional action

The state and local tax provision of the TCJA is already set to expire after 2025. Republicans in Congress would like to make it permanent, but that appears unlikely to happen before the mid-term elections this fall. If the Democrats take control of the House, they could try to overturn the loss of the deduction, perhaps paid for with an increase in the top individual tax rate.

They might not be successful in that effort at least until after the 2020 elections, but they could at least stop Republican efforts to make the loss of the deduction permanent.


It will be important for tax practitioners to monitor closely state actions taken this year in response to the TCJA. States may take actions that will require corresponding responses from taxpayers during the year to take maximum advantage of those tax changes, with implications for their federal tax liability on their 2018 tax returns. The responses to the state and local tax deduction are just one of the more active and interesting areas of activity for states this year that are worth monitoring.

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