A Complicated Equation: State and Local Tax Proposals and the SALT Deduction

While much focus and attention has been paid to proposed changes to federal tax policy, several states also have proposed, or passed, legislative changes to individual income and state estate taxes that may compound the government’s combined tax take significantly.

The issue is top-of-mind for many, with recent census data confirming an ongoing trend: While the reasons for interstate relocation are often complex, some Americans are “voting with their feet” in a continued migration from higher- to lower-tax states.

How High are Tax Rates in Your State?

Top Marginal Individual Income Tax Rates by State, 2020.

A SALT-y Debate

With federal, state and local tax policies all in flux, it is important to understand the impact of the hotly debated state and local tax (SALT) deduction, which was capped at $10,000 in 2017 (scheduled to sunset in 2025). The SALT deduction allows taxpayers who itemize their federal income tax deductions to “subtract” a portion of their state and local tax payments from their federal tab. Some in Congress are pushing to restore the deduction in full, while others would like to see it eliminated altogether.

Several issues and conflicting priorities are at play as all levels of government work to address budget deficits. In particular, lawmakers in high-tax states are seeking a full restoration of the deduction to stem the steady flow of residents to lower-tax states. In typical legislative tug-of-war, one possible outcome could be something short of either a full restoration or repeal. For example, the cap could be increased to $10,000 per taxpayer ($20,000 for a married couple filing jointly) and/or indexed over time for inflation.

The alternative minimum tax (AMT) and Pease limitation further complicate the ultimate value of a SALT deduction for taxpayers. The AMT, as the name indicates, is an alternative income tax computation method designed to limit the benefit of certain income tax deductions (including SALT) and exclusions to capture a minimum amount of tax from high income taxpayers. Taxpayers must calculate their liability under both tax codes and pay whichever results in greater liability. If a taxpayer’s liability is greater under AMT, the SALT deduction is lost altogether. While the Pease limitation is currently repealed, it may be reinstated in the future. The Pease limitation was a phased-in cap on the level of deductible itemized deductions based on the taxpayer’s adjusted gross income under the regular tax method. The AMT and Pease are never both applied.

Whatever the future holds for the SALT deduction, many other federal, state and local tax policy changes are colliding at a time when many wealthy families are already considering relocating to a lower-tax state. If you are considering moving out of a high-tax state, speak with a Northern Trust advisor to understand and prepare for the financial implications of your move.

Related Reading: Interstate Relocation Checklist