Deducting State & Local Tax on Your Federal Taxes

Deducting State & Local Tax on Your Federal Taxes
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Taxpayers were able to deduct an unlimited amount of property taxes, state and local income taxes and personal property taxes until ​2017​. About ​30 percent​ of all taxpayers chose to itemize deductions on their federal income tax return until that time, according to the Tax Policy Center, while ​70 percent​ opted to go with the standard deduction.

Most of the taxpayers who itemized were able to claim large deductions for state and local taxes, known as SALT deductions. The average SALT deduction for taxpayers with incomes above ​$100,000​ was ​$22,000​. But the Tax Cut and Jobs Act changed the tax landscape drastically in 2017.

What is the Tax Cut and Jobs Act?

The Tax Cuts and Jobs Act made several significant changes to the tax code when it went into effect in ​2018​. It almost doubled the standard deduction from ​$6,500​ to ​$12,200​ for single filers and people who are married filing separately. But more significantly, it placed a cap on the amount of state and local taxes that could be deducted on your tax return beginning. The maximum deduction for SALT is ​$10,000​ through the end of 2025 when the TCJA potentially expires.

This limitation is for the total SALT deduction, including property taxes and state and local income and sales taxes. But you must choose between deducting state and local income taxes or sales taxes. You can't deduct both.

You won't be affected by this limit and these rules unless you itemize your deductions. The decision becomes whether you should take the standard deduction or itemize your deductions on your federal tax return, because you can't do both.

What are the SALT Deductions?

SALT deductions fall into the following categories:

  • Income taxes
  • Sales taxes
  • Real estate taxes
  • Personal property taxes

Let’s explore how each of these taxes might affect your tax return.

State and Local Income Taxes

You can deduct the state and local income taxes withheld from your gross income during the year if you're paid wages or a salary. These amounts will be shown on the Form W-2 you receive from your employer.

Penalties and interest on unpaid or past-due taxes aren't deductible, but payments made on past-due taxes are deductible in the year they're paid. You can also deduct any estimated tax payments made during the year. You can deduct estimated tax payments in advance of next year's expected tax liability if you're doing some year-end tax planning.

Some states, including California, New York and New Jersey, have mandatory contributions to disability, family leave and unemployment funds. These compulsory contributions are also deductible.

Refunds from prior-year state and local income taxes don't reduce your deduction for current year state and local income taxes, but these refunds should be entered on line 1 of Schedule 1 that goes with the 2021 Form 1040, the tax return you'll file in 2022. They're considered to be additional income that you'll have to pay tax on.

State and Local General Sales Taxes

You must file Schedule A with your tax return if you're going to itemize your deductions. Check the box on line 5a to indicate your choice if you decide to use the state and local sales tax deduction. You have the option of using either the IRS sales tax calculator or your actual expenses to calculate your deduction.

Keep your receipts for any major purchases you made during the year and paid sales tax on. But you can only deduct the difference of the amount above the general sales tax rate if you purchase a vehicle and pay a sales tax that was higher than the general sales tax for the state.

Sales taxes paid on items that you use in your trade or business aren't deductible. They must be included with the income and expenses filed with the tax return for your business.

State and Local Real Estate Taxes

You can deduct real estate property taxes if they're assessed uniformly across a community and the revenue is used for governmental purposes. The IRS allows you to deduct taxes on such properties as:

  • Primary homes
  • Second homes
  • Co-op apartments
  • Land
  • Taxes on repair and maintenance of sidewalks, streets or water and sewage systems

Charges for services, such as trash collection or water consumption, are not deductible.

Taxes on real estate are deductible when they're paid. They're when your lender pays them, not when they're collected from you as part of your monthly mortgage payments, if your mortgage lender pays your real estate taxes out of an escrow account.

You can deduct real estate taxes paid on a second home if you use the home for personal use more than ​14 days each year​ or more than ​10 percent of the time​ that you rent the home. You can even allow your relatives, such as parents and grandparents, to use your vacation home and still qualify as long as you don't charge them rent.

Read More​: What is a Simple Tax Return?

State and Local Personal Property Taxes

The IRS allows deductions for personal property taxes on such items as RVs, cars and boats. Qualifying taxes must be:

  • Levied on personal property
  • Based on the value of the property
  • Imposed annually

You may be able to deduct a portion of the annual registration fee for your car if part of the fee is based on the car’s value, not its weight or year of manufacture.

Should You Itemize or Take the Standard Deduction?

The number of taxpayers who itemized their deductions rather than claim the standard deduction dropped from ​31.1 percent​ before passage of the TCJA to ​13.7 percent​ in ​2019​, according to the Tax Foundation.

Taxpayers who live in states with high property taxes such as New Jersey, New York and California won't be able to deduct as much as they have in the past due to the ​$10,000​ cap. At the other extreme, taxpayers in states like Alabama aren't affected as much by the cap on SALT deductions. Taxpayers in these states will most likely be able to take deductions for their home property taxes and still have room to deduct state and local income taxes and personal property taxes.

Each taxpayer should do the calculations for both methods, itemizing or claiming the standard deduction, to determine which gives them the better tax result. Each taxpayer has to analyze their own unique situation. Do you live in a high property tax state with high income tax rates? What about the sales tax rate? All these factors must be analyzed when trying to decide whether to itemize or take the standard deduction.