Most taxpayers are aware that when itemizing their deductions, property taxes paid regarding the residence of the taxpayer and income taxes paid in the state can be deducted as an itemized deduction—at least in most instances—on the Federal Income tax return.
This deduction under Code Section 164 of the Internal Revenue Code of 1986, as amended, allows for this general deduction.
However, to limit the deduction of state and local taxes and income taxes, on the Federal return, when itemizing deductions, Congress included a limit on this deduction when it passed the 2017 Tax Cuts and Jobs Act. That limit is found in Code Section 164 (b). The limit places a ceiling on the amount of deductions that can be claimed for property taxes on the residence, along with other personal income taxes, such as the income tax deduction on the Federal return for state income taxes paid, along with other potential limits. The overall limit is a total, for this group of deductions, of $10,000.
Since many taxpayers pay more than $10,000 for property and state income taxes in many states that have high property and income tax rates, this limit resulted in the loss of deductions for many taxpayers. The reaction to this loss of part of this deduction was to try and configure an approach that would allow the taxpayers to claim the full benefit of this tax deduction. This effort has been very popular in states where the property taxes and income taxes are very high, since taxpayers did not want to be denied these deductions. As such, many states worked on approaches to allow such deduction for their state citizens, when filing their federal income tax return.
One approach to avoiding this SALT limitation involved states allowing a pass-through entity, such as an LLC owned by the taxpayer individual, to pay the income taxes at the entity level. Then, such amount, per states involved in this work around, becomes a deduction (or a credit) on the federal income tax return when the pass-through entity determines the items that are passed through to the owners of the entity.
Although this position has been taken by taxpayers in many states, there was a question as to whether the IRS would challenge such deductions or credits. The IRS has not formally deemed this work around approach as improper.
(For more on this issue and the details of this approach, see IRS Notice 2020-75; see also the Checkpoint Edge article on this topic in https://checkpoint.riag.com/app/main/externalDoc?usid=168449x75326&DocID=ibc569ea84e104b09fa2d808981fc7ee5&begParm=y&docTid=T0JTAX%3A18865.1-2&feature=tcheckpoint&lastCpReqId=6a64f) See Varner, Randy, “The Salt Deduction Cap: State Pass-Through Entity Taxes as a Workaround,” J of Taxation (July 2023).
Because this SALT limitation will expire after 2025, based on the provisions for this law under the Tax Cuts and Jobs Act of 2017, this issue of SALT may not be important after 2025. However, this rule may be extended by Congress. Further, there are still 3 years remaining with the current SALT limitation. It may be that taxpayers will have to wait and see what Congress undertakes on this issue.
There are many unanswered questions on the SALT limitation and the attempts to work around this limitation. We will see what develops on this tax matter, since the issue needs to be addressed each year through 2025.
Professor Mark Lee Levine, University of Denver