The Tax Cuts and Jobs Act increased the standard deduction to $12,000 per person and $24,000 per couple (for 2018 and inflation-adjusted thereafter). This was great news for those who don’t itemize their deductions. However, for those itemizing deductions, there was some bad news in the new law, too. The law included a cap of $10,000 (not inflation adjusted) for state and local taxes (“SALT”), such as state and local income and real property taxes. The $10,000 limitation is the same for single taxpayers and those filing a joint return.
The impact of this new limitation varies from state to state. Some states have higher income taxes, such as New York and California. Other states have no income tax, like Florida, Texas, and Washington. Some states have high property taxes. This limitation hits residents of states like California, New York, and New Jersey particularly hard.
The SALT limitation sent taxpayers scrambling for innovative solutions. One solution, if it worked, would have allowed state income tax taxpayers to lower their state income tax bills if they made donations to specified funds. The hope was this would convert state income tax payments (subject to the $10,000 SALT cap) to a charitable contribution (not subject to the SALT cap). However, Treasury issued Proposed Regulation § 1.170A-1(h) which shut the door on this type of solution for contributions after August 27, 2018. Taxpayers who take a deduction despite the Proposed Regulation could open themselves to having their “charitable” deduction denied and owe additional interest and penalties, not what they’re trying to achieve.
However, a taxpayer could plan and legitimately maneuver around the $10,000 federal SALT limit. How? One strategy is to move to a state with lower state and local taxes. In other words, the taxpayer could be under the $10,000 SALT limit by reducing their SALT to under $10,000. For example, let’s say Tina Taxpayer lives in State A. She pays $5,000 in property taxes on her home and pays state and local income taxes of $20,000. Only $10,000 of the $25,000 total SALT is deductible from her federal income taxes. If Tina moves to State B, she may pay $8,000 in property taxes on a similar home, but State B has no state and local income tax. So, all $8,000 of her SALT is deductible on her federal income taxes.
A prior blog discussed the taxation of trusts generally and that they could be taxed as either grantor trusts or nongrantor trusts. A second strategy is to use nongrantor trusts to avoid the $10,000 limitation on SALT. The nongrantor trust is a separate taxpayer and gets its own separate $10,000 SALT limitation. (By comparison, a grantor trust isn’t a separate taxpayer and doesn’t get its own separate SALT limitation; it shares the grantor’s $10,000 limit.) By shifting assets to nongrantor trusts, any state income or property tax attributable to those assets would be a liability of the nongrantor trust, and could fall within the nongrantor trust’s separate $10,000 SALT limit. A third strategy is to divide ownership of real estate among taxpayers (possibly including nongrantor trusts), this may help make local property taxes deductible on the owners’ federal income tax returns.
The $10,000 SALT limit may prove burdensome for many taxpayers. However, for some taxpayers there may be legitimate ways to plan and do the Limbo to come in under the $10,000 limit.
Stephen C. Hartnett, J.D., LL.M.
Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128