Tax season has always been stressful. But the recent changes introduced with the Tax Cuts and Jobs Act (TCJA) may have you wondering what you are in for. You may have already seen in the news that some taxpayers, especially those living in high tax states, have already seen their taxes go up. Others are seeing their much-looked-forward to tax rebates disappear. This has to do with the dynamics created by the increased standard deduction and the cap on State and Local Taxes (SALT) for those who used to itemize their deductions instead.
Let us dig deeper into this.
Changes to the standard deduction
The standard deduction is a predetermined amount that every person is entitled to deduct from their income when calculating taxable income. And your standard deduction amount depends on your filing status as well as your disability status.
Here’s what standard deductions were for 2017 and what applies for 2018, the taxes you must file now, in 2019.
|For 2017 Taxes||For 2018 Taxes|
|Single taxpayers and married couples filing separately||$6,350||$12,000|
|Married couples filing jointly||$12,700||$24,000|
|Head of a household||$9,350||$18,000|
|Additional standard deduction for the aged or the blind||$1,250||$1,300|
|The additional amount is increased if the individual is also unmarried and not a surviving spouse.||1,550||1,600|
TCJA increased–and almost doubled–the standard deduction for all categories. Good news, right? Not for everyone, because TCJA also put a cap on itemized deductions at the same time. This has put a greater tax burden on those who live in high tax states and in certain other circumstances.
Here’s the problem: The standard deduction assumes you have deductible expenses less than the standard deduction amount.
A Cap on Itemized Deductions
Itemized deduction means listing each of your deductible expenses separately.
Here’s what people have been claiming as itemized deductions:
- Dental and medical expenses
- Deductible taxes—including property taxes and sales taxes you pay as state and local taxes
- Mortgage loan points and interest
- Interest from investments
- Charitable donations
- Tax preparation fees
- Employee expenses that are unreimbursed by employers
- Business expenses including certain travel expenses
- Job-related educational expenses
- Casualty, disaster and theft losses
That sounds like a pretty good deal if you have these expenses that were way beyond the threshold for standard deductions. Naturally, people who had deductible expenses that added up to more than their standard deduction could previously opt instead for itemized deductions.
For those who do have higher levels of deductions, it made sense to itemize their expenses and reduce their tax burden. But now, with the TCJA putting caps on popular itemized deductions such as the State and Local Taxes, many taxpayers are unable to deduct all of the expenses they could previously deduct.
State and Local Taxes Are Now Capped at $10,000
Before the TCJA, taxpayers could deduct their state and local taxes (SALT) as an itemized deduction when filing federal taxes. The SALT deduction includes property, income and sales taxes. Anyone who itemized could deduct property taxes in their entirety. However, they had a choice between deducting their income taxes and sales taxes. And there was no limit on how much you could deduct.
Beginning with 2018, the TCJA has capped the maximum SALT deduction at $10,000. This is definitely bad news if you live in a high-tax state. Let us see the implications of this capping.
Most people who itemized chose to deduct their state income taxes because those payments are generally higher than their sales tax payments each year. This is why people who live in states with high-income taxes–such as California, New York, New Jersey, and Maryland, among others–generally opted to deduct their state and local income taxes when they itemized. People who lived in high sales tax states such as Louisiana and Texas among others, but have very low or no income taxes usually opted to deduct their sales taxes when itemizing.
Here are the top 10 high tax states for 2018. The table breaks down the tax burdens by property, income and sales taxes.
|State||Total Tax Burden||Property Taxes||Income Taxes||Sales and Excise Taxes|
Your Income Bracket and the SALT Cap Impact
If you live in a high tax state, you’d be wondering how that is going to affect you. This depends on your income bracket. As your adjusted gross income (AGI) increases, so does the value of the SALT deduction when counted as a percentage of your AGI.
|The Value of the SALT Deduction Rises as Your Income Goes Up|
|Average Gross Income (AGI)||State and Local Tax Deduction Value as Percent of AGI||Percentage of Filers Itemizing with SALT|
|$0 – $24,999||2.3%||5.9%|
|$25,000 – $49,999||2.0%||19.1%|
|$50,000 – $99,999||3.8%||44.3%|
|$100,000 – $499,999||6.7%||80.2%|
|Source: Internal Revenue Service and associated calculations|
The middle column in the table shows how the value of the SALT deduction for a taxpayer goes up with their average gross income. No wonder then that, as their income rises, more and more taxpayers use SALT in their itemized deductions.
For 2016, less than 6 percent of taxpayers earning below $25,000 used the SALT deduction. In contrast, nearly 20 percent—that is one in five–earning between $25,000 to $50,000 and over 44 percent of those earning between $50,000 and $100,000 used SALT as part of their itemized deductions.
Take note also that a great majority of taxpayers with AGIs over $100,000 are utilizing SALT to offset their federal tax burden.
SALT Deduction In High-Tax States
SALT deduction is very commonly used by itemizers in high-tax rates like New York, New Jersey, Connecticut, California, Maryland, Oregon, Massachusetts, Minnesota, Rhode Island and the District of Columbia.
Most articles you are likely to see talk about the benefit of SALT going overwhelmingly to those earning over $100,000. While that may be true in statistical terms, take note of the AGI per filer in all these states in the table below. Taken overall, the AGI per filer works out to way less than $100,000 in all of the high-tax states.
A large number of people, way more than quoted data shows on the surface, are making use of the SALT deduction and may have some skin in the game when it comes to the SALT cap.
|SALT Deduction Data By State – High Tax States|
|Deduction as % of AGI||State Share||AGI Per Filer||Percent of Itemizers|
|District of Columbia||7.10%||0.40%||$93,023||40.20%|
Source: Tax Foundation
TCJA cushions the blow for high-income taxpayers
When it comes to the SALT cap you are in luck if you belong to a higher income bracket.
The provisions of the TCJA had a number of offsetting benefits that cushioned the high-income taxpayers from the blow resulting from capping of SALT at $10,000. These include the lower statutory tax rates, a much larger Alternative Minimum Tax Exemption than before and a reduction in the corporate income tax.
Tax Foundation says that “on net, these taxpayers tended to have a lower liability under current law, even with the capped SALT deduction.”
The real squeeze will come to those who are earning below $100,000—that is a vast majority of American taxpayers. If you fall in this group and live in a high tax state, you are likely to be affected by the SALT deduction cap.
What happens if you have way more in deductible expenses than what can be offset even with the increased standard deduction? If this is the case, you are likely to see you taxes for 2018 increase when you file this year (in 2019).
For a lot of taxpayers earning less than $100,000, the new tax law—which increases standard deductions, eliminates some personal deductions and caps the SALT deduction—also gives an interesting choice. Should you itemize or not when filing for taxes this year?
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