The Surprising Impact of the SALT Deduction Limit
As we move through the current tax season, clients will be reminded how the Tax Cuts and Job Act (TCJA) has impacted their tax situation.
New Jersey has some of the highest state income and property taxes in the country. When the TCJA was enacted, many of our clients were justifiably concerned that the new $10,000 limit on the deductibility of those taxes on their Form 1040 would negatively affect them. We were equally concerned and began projecting their 2018 tax as their 2017 tax returns were prepared so that we could properly plan for the assumed increase in tax. The results were surprising. (It is noteworthy that the sample size contained only 100 subjects; thus, the results are certainly not statistically valid, but the indications are intriguing nonetheless.)
After completing a client’s 2017 tax return, the tax software was used to subject their exact 2017 tax return to the new 2018 tax rules with zero adjustments. To be clear, all income and deduction items remained unchanged, and the projector used the same income and deductions and subjected them to the new rules and tax tables to compare apples to apples. The additional 20-percent qualified business tax deduction (Section 199A) was not used because there was not enough information at the time to make that adjustment, and the software was not easily able to make those computations without manual overrides.
As expected, most clients experienced an increase in taxable income. In fact, 79 percent had increased taxable income. On average, the increase was 15.64 percent and the median increase was 8 percent. Although a small contributing factor to the taxable income increase was the loss of the domestic production activity deduction, the primary drivers were the reduced SALT deduction and removal of personal exemptions. But even though 79 percent had increased taxable income, only 24 percent of those had an increase in tax. This was an incredible result since it was fully expected that everyone would experience an increase in tax due to the SALT limitations alone.
So how could this be explained? The primary purpose of the TJCA was to reform the individual income tax code by lowering tax rates on wages, investment and business income; broadening the tax base; and simplifying the tax code. But with so many variables changed, how is it possible to measure the effect of the changes and identify who the winners and losers are since no two tax returns are ever the same? Also, a full 34 percent of those included in the analysis were in AMT. Since the largest factor that caused them to go into AMT was the SALT deduction itself, were our clients ever really getting the full deduction for their state and local taxes anyway? With the limitation of that deduction to $10,000, it did not create an addback for AMT, so AMT was effectively removed.
No change was made to the income range of the lower two brackets, but the stretching of the amount of income subjected to tax and the decreased tax rate itself in the subsequent brackets in the new 2018 tax tables caused the reduction of taxes in every bracket except the 10-, 32- and 35-percent brackets in this analysis. There were several drivers that contributed to the changes, but for the New York metropolitan area and our clients, the largest contributor to tax savings seemed to be the new tax brackets themselves. As soon as the 20-percent small business deduction is considered, the winners in the middle to higher brackets are bound to increase.
According to the data gathered thus far, our clients will not be as negatively affected as assumed since 81 percent of them achieved a median tax decrease of 12 percent. Of course, every client is different, and no two years will ever be the same. When I told one client of his personal (positive) results he stated begrudgingly, “Well, taxes in New Jersey are still too high.” That, my friend, is a different discussion.
Ann-Marie Long, CPA, CITP, is a senior tax accountant at SKC & Co. CPAs, LLC. She is a member of the NJCPA and can be reached at firstname.lastname@example.org.
This article appeared in the January/February 2019 issue of New Jersey CPA magazine. Read the full issue.