SALT Cap Rule and Its Impact: What You Need to Know

The ongoing debate around the federal $10,000 state and local tax (SALT) deduction cap is heating up, with states like New York, New Jersey, and Connecticut challenging an IRS rule that limits their workarounds to this cap. The outcome of this legal battle could significantly affect taxpayers in states where SALT obligations exceed the federal deduction limit, as well as influence the revenue the federal government collects. 

Here’s a breakdown of the issue, its potential impact, and how consulting with a tax advisor can provide clarity in navigating these complex tax laws. 

Understanding the SALT Deduction Cap 

As part of the 2017 Tax Cuts and Jobs Act, Congress placed a $10,000 limit on the amount of state and local taxes that individuals and married couples filing jointly can deduct on their federal income tax returns. This cap disproportionately impacts taxpayers in states with higher property taxes and income tax rates, such as New York, New Jersey, and Connecticut. 

In response, these states developed workarounds by creating charitable contribution programs that allowed residents to claim state tax credits in exchange for donations. These contributions could then be deducted on federal returns under the charitable contribution deduction rules, effectively circumventing the $10,000 cap on SALT deductions. 

The IRS Rule and States’ Challenge 

In 2019, the IRS issued a rule closing these state-level loopholes by limiting the amount taxpayers could deduct for donating to state-affiliated charities. Under this rule, taxpayers could no longer fully deduct charitable donations if they received state tax credits in return, weakening the states’ workarounds. 

New York, New Jersey, and Connecticut have challenged the IRS’s authority to implement this rule, arguing that it oversteps the agency’s power and violates the Administrative Procedure Act (APA). According to the states, the rule arbitrarily distinguishes between state tax credits (which aren’t deductible) and state and federal tax deductions (which are). They argue that this distinction contradicts the statutory language governing charitable contribution deductions. 

A federal district court sided with the IRS in 2023, ruling that the agency complied with the necessary rulemaking process. However, the states have appealed this decision to the US Court of Appeals for the Second Circuit, asserting that the rule is contrary to federal tax law (specifically IRC Section 170) and should be overturned. 

Why This Matters to Taxpayers 

If the appeals court sides with the states, high-income taxpayers in states with large SALT obligations may be able to continue using charitable deductions to lower their federal tax bills. Conversely, if the IRS’s rule is upheld, these taxpayers will face the full brunt of the $10,000 deduction limit, potentially increasing their federal tax burden. 

For businesses, real estate investors, and high-net-worth individuals in states with high taxes, the ruling could have significant financial implications. This case is an important reminder of how quickly tax laws can change and how complex tax planning can become when both federal and state laws are involved. 

How a Tonneson + Co Tax Advisor Can Help 

Tax planning is complex, especially when navigating the ever-evolving landscape of state and federal tax regulations. Consulting with a knowledgeable tax advisor can help ensure you are making informed decisions and exploring all available options to reduce your tax liability. 

Whether you’re an individual or a business affected by the SALT deduction cap, a tax advisor can provide personalized strategies and guidance. They can also help you stay up to date with legal developments like the SALT cap challenge, ensuring you remain compliant and optimize your tax position in light of any potential changes. 

At Tonneson + Co, we specialize in helping individuals and businesses navigate complex tax laws and develop strategies to maintain tax efficiency. If you have any questions about the SALT deduction cap or how it may affect your tax situation, reach out to one of our experienced tax advisors today. We’re here to help you stay ahead in an ever-changing tax landscape.