Republicans are framing a new tax law as a win for middle-income Americans. Yet, the most substantial tax benefits seem to be going to wealthier individuals, especially in high-tax states like California and New York.
This shift occurs because the law raises the amount allowed for state and local tax deductions, commonly referred to as SALT. It offers the chance for federal taxpayers to itemize their deductions for state and local income taxes as well as property taxes. Those who can benefit from itemizing rather than taking the standard deduction tend to be the wealthiest, particularly in areas where living costs and tax rates are high. In fact, a report by the Bipartisan Policy Center (BPC) shows that only 7% of taxpayers earning less than $200,000 in 2022 were affected, while 38% of those earning over $200,000 benefitted.
The previous tax law had a cap, limiting deductions to $10,000, established during the first Trump administration in 2017. Under the new legislation, that cap has increased to $40,000 but will gradually phase out for individuals earning over $500,000.
Taxpayers in states like California, Illinois, New Jersey, and New York are poised to benefit the most from these changes. According to the BPC, 40 out of 50 council districts are impacted by the cap, with thirteen of the top fifteen located in California and New York. The previous caps primarily affected those making over $200,000 annually, as many lower earners simply didn’t have enough SALT to be significantly impacted by the $10,000 limit, a point emphasized by the BPC and further backed by the Tax Foundation.
A map derived from BPC data illustrates the gap between average SALT and the former $10,000 cap across various council districts. A bigger difference indicates more potential benefit from increasing the cap.
The salt cap’s implications have sparked considerable debate, particularly among Republican lawmakers in high-tax regions who are promoting the change, presenting it as a benefit for the affluent. It turns out to be one of the costliest elements of the new law, aiming to fund many tax credits by slashing Medicaid and food assistance, adding a hefty $3 billion to the national debt. On top of that, lifting the SALT caps is projected to increase this debt by $180 billion over the next ten years.
As a result, this policy will only remain in effect until 2030, which aligns with various individual tax modifications included in the law, such as measures targeting tax rates on tips and overtime.
Mark Garson, a tax advisor, notes, “It’s a growing relief, but only temporary. Congress will need to revisit this.”
Phase-Out of Salt Caps
There’s a key detail about the new law for high-income households. The $40,000 SALT cap will start to phase out for those making $500,000 and drop to $10,000 for those earning more than $600,000.
According to Ben Rizzuto, a Wealth Strategist, around 30% of SALT deductions will diminish beyond the $500,000 mark. This means as someone’s income rises from $500,000 to $600,000, their taxable income could increase significantly. Rizzuto also points out that both the cap and income thresholds will increase by 1% annually through 2029. He advises wealthy taxpayers to carefully plan for income changes or consider moving funds through Roth conversions or IRA distributions. Consulting with a financial professional about how these tax changes might impact overall financial planning is also wise.
Moreover, since the increased SALT cap could boost tax refunds, Rizzuto suggests that wealthy taxpayers keep a close eye on their income and deductions. Adjusting withholdings may also be beneficial, depending on whether they prefer immediate cash flow or the promise of a tax refund.
Workaround for High-Income Earners
Interestingly, the law introduces a workaround for higher earners that can entirely bypass the SALT cap. Known as the Passthrough Entity Tax (PTET), this provision allows owners of pass-through entities, like certain professionals and business partners, to navigate around the limit by paying state taxes at the business level rather than the individual level.
