Understanding the SALT Cap Under the Big Beautiful Tax Act
The State and Local Tax (SALT) deduction has been a significant feature of the federal tax code since the implementation of the modern income tax following the ratification of the Sixteenth Amendment in 1913. This deduction has historically allowed taxpayers to reduce their federal taxable income by the amount paid in state and local taxes, including income, property, and sales taxes. However, the Tax Cuts and Jobs Act (TCJA) of 2017 dramatically altered this longstanding tax benefit by implementing a cap on SALT deductions. More recently, the One Big Beautiful Bill Act has introduced modifications to this cap, creating important considerations for taxpayers across the country.
The SALT Cap: Background and Implementation
Prior to the TCJA, taxpayers who itemized deductions could deduct the full amount of state and local taxes paid, including property taxes, income taxes, and either sales taxes or income taxes (taxpayers could choose which provided the greater benefit). This deduction was particularly valuable for residents of states with higher tax burdens.
The TCJA, signed into law in December 2017, implemented a $10,000 cap ($5,000 for married individuals filing separately) on the total amount of state and local taxes that could be deducted on federal income tax returns. This cap applies to the aggregate of:
- State and local real property taxes
- State and local personal property taxes
- State and local income taxes (or sales taxes, if elected instead)
Modifications Under the Big Beautiful Tax Act
The One Big Beautiful Bill Act, enacted as 119 P.L. 21, has introduced significant modifications to the SALT cap. While the original legislation maintained the $10,000 limitation regardless of filing status, the new legislation provides some relief by increasing the cap amounts based on filing status.
The modifications include:
- Increased cap amounts based on filing status
- Indexing for inflation in future years
- Extended timeline for the modified caps
Implications for Taxpayers
The SALT cap has significant implications for taxpayers, particularly those residing in states with higher tax burdens. Taxpayers in states like New York, New Jersey, Connecticut, and California, which typically have higher state income and property taxes, are more likely to be affected by the cap.
For many taxpayers, the SALT cap has reduced the tax benefit of homeownership, as property taxes that exceed the cap (when combined with state income taxes) are no longer fully deductible. This has potentially affected housing markets in high-tax jurisdictions.
The cap has also influenced taxpayers' decisions about whether to itemize deductions or take the standard deduction. With the TCJA's increase in the standard deduction and the limitation on SALT deductions, fewer taxpayers find it beneficial to itemize.
Workarounds and Responses
In response to the SALT cap, several states have implemented or considered workarounds to mitigate its impact on their residents. One notable approach has been the creation of state-administered charitable funds. Under these programs, taxpayers can make "charitable contributions" to state-established funds and receive state tax credits in return. The intention was to allow taxpayers to convert state tax payments into charitable contributions, which are not subject to the SALT cap.
However, the Treasury Department and IRS responded to these workarounds by issuing regulations that treat the receipt of state tax credits in return for charitable contributions as a "quid pro quo" that reduces the federal charitable deduction.
A more successful workaround has emerged for business owners. The IRS issued guidance in Notice 2020-75 permitting partnerships and S corporations to make an annual election to pay state and local taxes at the entity level. Partners and shareholders then receive a tax credit equivalent to the pass-through entity tax (PTE tax) that they can use on their personal income tax returns. Since the SALT cap applies only to individuals, not businesses, this effectively allows for the full deduction of state and local taxes for qualifying business owners.
Conclusion
The SALT cap under the Tax Cuts and Jobs Act, as modified by the One Big Beautiful Bill Act, represents a significant change to the federal tax treatment of state and local taxes. While the cap continues to limit deductions for many taxpayers, the recent modifications provide some relief, particularly for married couples filing jointly.
Taxpayers should carefully consider how the SALT cap affects their overall tax situation and explore potential planning opportunities, including entity-level tax elections for business owners. As with any tax matter, the specific impact depends on individual circumstances, and strategies should be tailored accordingly.
At Turley Law, we understand the complexities of federal tax law and can help you navigate these changes to optimize your tax position. Contact our experienced tax attorneys today for personalized advice on how the SALT cap affects your specific situation and what strategies might be available to you.
Disclaimer: This blog post is intended for informational purposes only and does not constitute legal or tax advice. Tax laws are complex and subject to change. Please consult with a qualified tax professional for advice specific to your situation.