The Republican party is proud of its new tax law, which they say is good for middle-income Americans. There are some big tax cuts in the bill, but most of them are for wealthy people across the country, especially in high-tax places like California and New York.
This is because the law raises the amount of state and local taxes (SALT) that can be deducted. This lets federal taxpayers who itemise their deductions fully deduct state and local income taxes as well as property taxes. It helps wealthy taxpayers in states with high tax rates and a high cost of living the most, since they can choose to itemise over the standard deduction. The Bipartisan Policy Centre (BPC) says that in 2022, only 7% of taxpayers making less than $200,000 claimed itemised benefits, but 38% of taxpayers making more than $200,000 did.
The 2017 tax bill, which was passed by the first Trump administration, was the first to put a limit on this benefit. It said that taxpayers could only deduct $10,000. Under the new rule, the limit has been raised four times, to $40,000. For people making more than $500,000, it starts to go down.
Several studies show that taxpayers in California, Illinois, New Jersey, and New York will gain the most from the cap. These states have 40 of the 50 most populous congressional districts that will be affected. BPC says that 13 of the top 15 are in just California and New York. People who made more than $200,000 a year were mostly affected by the old cap. People who made less than that “typically don’t pay enough SALT to be significantly affected by the $10,000 cap,” says BPC. In fact, the Tax Foundation says that the bottom 80% of earners would not get any better.
BPC’s data shows the gap between the average SALT paid and the $10,000 cap in each congressional district. The map below shows this. The bigger the gap, the more the households can gain from the higher cap.
One of the most controversial parts of winning the bill was what to do about the SALT cap. Republicans from high-tax states like New York and California pushed for it, while Republicans from lower-tax states called it a gift to the rich. It’s also one of the most expensive parts of the new law. To pay for its many tax breaks, it cuts money from food stamps and Medicaid, but the national debt will still grow by more than $3 trillion. The debt will grow by $180 billion over the next 10 years because the SALT cap was raised.
Even so, the rule is only in place until 2030, just like many of the other changes to the law that affect individual taxes, such as new rules that lower taxes on tips and extra.
Marc Gerson, a member of Miller & Chevalier and former majority tax counsel for the House Ways and Means Committee, says, “It’s more pain relief, but it’s only temporary.” “That’s why Congress will have to look at it again.”
How the SALT cap phases out
One part of the new law that high-income families should pay attention to is that the $40,000 SALT cap starts to go away for people making $500,000 or more, and it drops to $10,000 for people making $600,000 or more.
Ben Rizzuto, financial strategist at Janus Henderson Investors, says, “The provision requires that the SALT deduction be cut by 30% of income over $500,000.” “The phaseout of the deduction could mean that a person’s taxable income could go up by $130,000 if their income goes from $500,000 to $600,000.”
The cap and the income limits will both go up by 1% every year until 2029. Even so, Rizzuto says that because of the phase out, it makes sense for rich taxpayers to “carefully plan around changes in income” or gains from Roth conversions or IRA distributions. He also tells taxpayers to talk to their accountant or financial advisor about how these changes to the tax law will affect their taxes and general financial plan.
Rizzuto also says that because the SALT cap has been raised, rich taxpayers are more likely to get a bigger tax refund next year, as long as their income and other deductions don’t change a lot. He says that changing your withholdings now might be a good idea if you will be able to apply.
If a taxpayer expects a tax return, he says, they need to decide if they’d rather have their money now or later when it comes to withholdings. “If they want it right away, lowering the amount taken out of their pay cheque would make sense so they can get more of it and use the extra money for other financial goals.” If they’d rather get a return from the IRS, it makes sense to leave withholdings alone.
SALT workaround
Having said that, the law still allows some high earners a way around the cap, which would basically get rid of it altogether. A lot of states let pass-through owners and partners escape the cap. This is called the pass-through entity tax, or PTET.
In this case, it helps business owners like car sellers, lawyers, doctors, and others who run professional service firms, but not their workers. This basically lets these people pay state tax on their pass-through income at the entity level instead of the person level, which gets them around the federal cap.
