New Tax Law Quadruples SALT Deduction Cap To $40,000

High-income taxpayers in California and New York are poised to receive significant tax benefits due to changes in the state and local tax (SALT) deduction under the new tax legislation. The legislation increases the deduction level for SALT, allowing federal taxpayers who itemize their deductions to fully deduct state and local income taxes as well as property taxes. This change is particularly advantageous for wealthy individuals in high-tax states, who are more likely to itemize their deductions rather than take the standard deduction.

The 2017 tax bill, passed under the first Trump administration, introduced a cap on the SALT deduction, limiting it to $10,000. The new law quadruples this cap to $40,000, with the cap beginning to phase down for taxpayers making over $500,000. This increase is expected to benefit taxpayers in states like California, Illinois, New Jersey, and New York the most, as these states have a high cost of living and high tax rates. The old cap primarily affected taxpayers making over $200,000 per year, while those earning less than that were typically not significantly affected by the $10,000 cap. In fact, the bottom 80% of earners would see no benefit at all from the increased cap.

The provision to increase the SALT cap was one of the more contentious aspects of the new legislation, with Republican politicians from high-tax states pushing for it while those from lower-tax states criticizing it as a giveaway for the rich. The increased SALT cap adds $180 billion to the national debt over the next 10 years, making it one of the most costly aspects of the new legislation. The provision is set to last only through 2030, after which Congress will need to revisit it.

One important aspect of the new law for high-income households is the phase-out of the $40,000 SALT cap. The cap begins to phase out for those earning $500,000 and is reduced to $10,000 for those earning $600,000 and above. This phase-out means that if an individual’s income increases by $100,000—from $500,000 to $600,000—their taxable income could increase by $130,000. Both the cap and the income thresholds will increase by 1% yearly through 2029. Wealthy taxpayers are advised to carefully plan around income changes or increases through Roth conversions or IRA distributions, given the phase-out. They should also discuss how these tax law changes will affect their tax situation and overall financial plan with their financial advisor or accountant.

The increased SALT cap means wealthy taxpayers have a higher probability of a bigger tax refund next year, assuming their income and other deductions will not change significantly. If they qualify, it might make sense to change their withholdings now. Taxpayers need to decide whether they would rather have their money now or later. If they want it now, then decreasing withholdings to receive more in their paycheck would make sense and allow them to utilize those funds for other financial goals. If they would rather receive a refund from the IRS, then leaving withholdings as is would make sense.

The legislation also preserves a workaround for some high earners that would effectively eliminate the cap altogether. Called the pass-through entity tax, or PTET, many states allow pass-through owners and partners to avoid the cap. This benefits people like car dealers, law firm partners, doctors, and other owners of professional service firms. Essentially, this allows these taxpayers to pay state tax at the entity level, rather than the individual level, and in doing so avoid the federal cap.