SALT Deduction Cap Optimization for High-Tax States

• admin
• February 16, 2025
• 6 min read

Understanding Salt Deduction: Tax Implications

Navigating the complexities of state and local taxes can be challenging, especially for residents in high-tax states affected by the $10,000 cap on State and Local Tax (SALT) deductions. However, innovative strategies have emerged to help taxpayers mitigate this limitation and optimize their tax situations.

Key Takeaways

• Pass-Through Entity (PTE) Tax Regime: A potential workaround allowing certain business owners to bypass the SALT deduction cap.
• Charitable Contribution Strategies: Some states offer programs enabling taxpayers to receive state tax credits for charitable donations, which may be deductible federally.
• Retirement Contributions and Itemized Deductions: Maximizing contributions to retirement accounts and other deductible expenses can help reduce taxable income.

Understanding the SALT Deduction Cap

The Tax Cuts and Jobs Act of 2017 introduced a $10,000 cap on SALT deductions, significantly impacting taxpayers in high-tax states and raising questions about the need for a refund and tax reform. This cap limits the amount of state and local taxes that can be deducted on federal income tax returns, leading to higher taxable income for many.

Exploring the Pass-Through Entity (PTE) Tax Regime

One effective strategy to circumvent the SALT deduction cap is the Pass-Through Entity (PTE) tax regime. Under this approach, states allow pass-through entities—such as S corporations, partnerships, and Limited Liability Companies (LLCs)—to pay state income taxes at the entity level. This payment is then deductible on the entity’s federal tax return, effectively bypassing the SALT cap.

How the PTE Tax Regime Works

1. State Legislation: The state enacts legislation permitting PTEs to elect to pay state income taxes at the entity level.
2. Entity Election: The PTE elects to be taxed at the entity level for state income tax purposes.
3. Tax Payment: The PTE pays the state income tax directly.
4. Federal Deduction: The PTE deducts the state tax payment on its federal tax return, reducing federal taxable income.
5. Owner Credit: Owners receive a state tax credit or adjustment to prevent double taxation.

States Implementing PTE Taxes

As of 2025, several high-tax states have adopted PTE tax regimes, including California, New York, and New Jersey.

Considerations for PTE Tax Election

• Eligibility: Not all PTEs qualify; eligibility criteria vary by state.
• Compliance: Electing the PTE tax may introduce additional compliance requirements.
• State-Specific Rules: Each state’s PTE tax regime has unique provisions and implications.

Charitable Contribution Strategies as a SALT Deduction Workaround

Some states have developed programs where taxpayers can make charitable donations to state-approved funds and receive a state tax credit in return. This method aims to convert non-deductible state tax payments into federally deductible charitable contributions.

How Charitable Contribution Workarounds Function

This workaround is based on the idea that charitable donations remain deductible under federal tax law, while the SALT deduction is capped at $10,000, influencing the calculation of a taxpayer’s overall tax bill. States with these programs allow taxpayers to donate to state-sponsored funds, providing them with a state tax credit that reduces their state income tax liability. If structured correctly, this allows taxpayers to benefit from a federal charitable deduction in place of a disallowed SALT deduction.

Example of a Charitable Contribution Workaround

Imagine a taxpayer in a high-tax state owes $15,000 in state income and personal property taxes. Under the current IRS rules, due to the SALT deduction cap, they can only deduct $10,000 on their federal return, meaning $5,000 is non-deductible. However, if their state offers a charitable contribution program, they could instead donate $5,000 to a state-approved charitable fund. In exchange, they receive a state tax credit equal to 90% of their donation.

States Offering Charitable Contribution SALT Workarounds

As of 2025, some high-tax states have implemented bipartisan programs, including New York, New Jersey, Connecticut, and California.

IRS Regulations & Limitations on This Strategy

The Internal Revenue Service (IRS) has issued regulations addressing these arrangements, and the federal deductibility of such contributions may be limited. In IRS Notice 2019-12, the agency ruled that if a taxpayer receives a state tax credit exceeding 15% of their donation, they must reduce their federal charitable deduction accordingly.

Potential Benefits and Risks

Benefits:

• Increased federal tax deductions by converting non-deductible state tax into deductible charitable contributions.
• State tax credits reduce direct state tax liability, potentially offsetting increases in property taxes.
• Potentially higher tax savings, especially for those who already make charitable contributions.

Risks and Considerations:

• IRS scrutiny: The IRS has strict limitations on how much of the donation can be deducted if a tax credit is received.
• State-specific eligibility: Programs vary widely by state, and not all donations qualify for federal deductions.
• May not work for all taxpayers: Those taking the standard deduction rather than itemizing may not benefit from this strategy.

Who Should Consider This Strategy?

• High-income earners in high-tax states with significant SALT liabilities.
• Business owners or individuals already making large charitable donations.
• Itemizing taxpayers looking for additional deductions.

Maximizing Other Deductions

Beyond SALT-specific strategies, taxpayers can explore other avenues to reduce taxable income:

• Retirement Contributions: Maximize contributions to tax-advantaged retirement accounts like 401(k)s and Individual Retirement Accounts (IRAs).
• Mortgage Interest: Deduct mortgage interest on qualified residence loans, subject to limitations.
• Medical Expenses: Deduct unreimbursed medical expenses exceeding 7.5% of Adjusted Gross Income (AGI).

Frequently Asked Questions

Q: What is the SALT deduction cap?
A: The SALT deduction cap limits the amount of state and local taxes that can be deducted on federal income tax returns to $10,000.

Q: How does the PTE tax regime help bypass the SALT cap?
A: By allowing pass-through entities to pay state taxes at the entity level, these taxes become deductible on the entity’s federal return, effectively circumventing the SALT cap.

Q: Are there risks associated with these SALT workaround strategies?
A: Yes, strategies like the PTE tax regime and charitable contribution programs can be complex and may have varying implications based on individual circumstances and evolving tax laws. It’s essential to consult with a tax professional to understand the potential risks and benefits fully.

Unlocking New Avenues for Tax Relief

While the SALT deduction cap presents challenges for taxpayers in high-tax states, strategies like the PTE tax regime and certain charitable contribution programs offer potential avenues for relief. However, these approaches can be complex and may carry risks. It’s crucial to consult with a tax professional to determine the most appropriate strategy for your specific situation. For more information on managing your tax obligations, consider exploring resources like FileLater.com for guidance on tax extensions and planning.