Understanding the SALT Deduction and Its Impact on Your Taxes
With another tax season underway, chances are you’re hoping for a nice return from Uncle Sam. That means understanding the potential deductions available to you and reducing your tax liability as much as possible. Let’s take a closer look at the state and local tax deduction (SALT) and see whether it’s worth exploring more before you file.
What is the state and local tax deduction (SALT)?
It allows those in high-tax states to deduct the money they spend on local and state taxes. The deduction went into effect during the 2019 tax year and included a cap of $10,000. Today, SALT remains a topic of conversation among taxpayers, financial advisors, and U.S. representatives looking to adjust the deduction cap.
Before assuming you can take the SALT deduction, you need to look back on how you normally file. If you choose the standard deduction of $6,500 to $12,000 for individual filers, you are not eligible for this particular deduction. The SALT deduction is only available to those who itemize.
How does it work?
Let’s say you decide to forgo the standard deduction and itemize your deductions instead. The SALT deduction enables you to deduct what you’ve paid in income and property taxes. Now, if you live in a state with low or no income taxes, you can opt to deduct your sales taxes.
Here are two examples to consider. Perhaps you live in a state with one of the highest income tax rates in the country, such as California. The SALT deduction gives you the flexibility to deduct some of your state and local income taxes if you itemize.
However, what if you live somewhere like Texas, with no or minimal state income taxes? You could still itemize and deduct your sales taxes since those are quite higher than other states. Just note SALT deductions tend to be most prevalent with income and property taxes.
Should you use the deduction?
We can’t say for certain because we aren’t tax professionals. While you might not benefit from the SALT deduction, your friend or neighbor might. It’s why we suggest talking to a tax expert and understanding your options before you file.
We can tell you that higher earners tend to itemize more than those who earn less. In turn, it could make sense to use the SALT deduction since it’s a viable way to keep more of your money. Again, circumstances vary by the taxpayer.
Now for another critical question: who benefits the most from this deduction? Well, even with a $10,000 deduction for all taxpayers, the savings will also be different for everyone. Bankrate tells us that “those in lower tax brackets would enjoy lower savings with the SALT deduction, while those in the highest tax bracket could save up to $3,700 in federal income taxes.”
What’s the latest SALT deduction cap?
The current SALT deduction cap remains at $10,000 under the Tax Cuts and Jobs Act of 2017. Though it expires in the next few years, policymakers want to raise the cap much sooner to further reduce taxable income for those in high-income states such as New York, New Jersey, and California. According to CNBC, the proposed spending package would increase the deduction limit to a whopping $80,000 through 2030.
Experts believe such a plan would cause earners in states with high income taxes to rethink their tax filing strategy. We would likely see significantly more taxpayers in these locales choosing to itemize over the standard deduction. As the article mentions, passing the legislation requires votes from all 50 Democratic senators.
Know your options at tax time
Many first-time homebuyers aren’t aware of the tax benefits of owning a home. So, if you purchased a home in the last year, be sure to check out our guide to mortgage interest tax deductions. You’ll learn that not only is mortgage interest still deductible but that you could also be eligible for a tax break if you have a second mortgage or home equity line of credit (HELOC).
Alternatively, maybe you’ve been renting for a while but have been setting funds aside for a house. How much faster could you become a homeowner if you put your entire tax refund into this account? Another idea is earmarking some of these funds for a down payment and using the rest to pay off high-interest debt and improve your credit score.
*American Financing does not offer tax advice. Consult a tax professional if you have tax-related questions regarding your home purchase or refinance.