7.3 State & Local Taxes (SALT $40K Cap)

State & Local Taxes (SALT) Deduction – OBBBA EXPANSION

The State and Local Tax (SALT) deduction is one of the most significant itemized deductions. The 2017 Tax Cuts and Jobs Act (TCJA) imposed a $10,000 cap that radically changed the itemizing landscape. The One Big Beautiful Bill Act (OBBBA), signed July 4, 2025, dramatically expanded the cap for 2025-2029 before a scheduled reversion in 2030.

The Expanded SALT Cap for 2025

Key Rule for 2025 (post-OBBBA): The total deduction for all state and local taxes combined is limited to:

• $40,000 for Single, HoH, MFJ, and QSS filers
• $20,000 for Married Filing Separately (MFS)

This cap applies to the sum of:

• State and local income taxes (OR general sales taxes)
• State and local real property taxes
• State and local personal property taxes

High-Income Phase-Down

The $40,000 cap phases down for higher-income taxpayers but never falls below $10,000:

• Phase-down begins at MAGI > $500,000 MFJ / $250,000 MFS (and $500,000 for Single/HoH)
• Reduction = 30% of MAGI exceeding the threshold
• Floor: the cap cannot be reduced below $10,000 ($5,000 MFS)

Phase-down formula: SALT cap = max($10,000, $40,000 – (MAGI – $500,000) × 30%)

Inflation Adjustment: The expanded cap inflates 1% per year through 2029.

2030 Reversion: Absent further legislation, the cap reverts to $10,000 ($5,000 MFS) in 2030.

Phase-Down Example (2025)

Sarah and Tom, MFJ, MAGI of $600,000, paid $50,000 in combined SALT:

• Excess MAGI = $600,000 – $500,000 = $100,000
• Reduction = $100,000 × 30% = $30,000
• Reduced cap = $40,000 – $30,000 = $10,000 (floor reached)
• Their SALT deduction is $10,000 (cannot fall below the floor regardless of MAGI)

Couple at MAGI $550,000 with $45,000 SALT:

• Reduction = ($550,000 – $500,000) × 30% = $15,000
• Reduced cap = $40,000 – $15,000 = $25,000
• Deduction = lesser of $45,000 or $25,000 = $25,000

Components of the SALT Deduction

The SALT deduction reported on Schedule A (Lines 5a-5e) consists of three potential components:

Line 5d: Total state and local taxes (5a + 5b + 5c) Line 5e: Enter the smaller of Line 5d or the applicable cap (after any phase-down)

The Income Tax vs. Sales Tax Election

Taxpayers must make an annual choice between deducting:

1. State and local income taxes, OR
2. State and local general sales taxes

You cannot deduct both for the same tax year.

Which to Choose?

Calculating the Sales Tax Deduction

If electing sales tax, taxpayers can use:

1. Actual receipts – Track and total all sales tax paid
2. IRS Optional Sales Tax Tables – Based on income, family size, and state
3. IRS Sales Tax Deduction Calculator at IRS.gov

Bonus: When using the optional tables, you may ADD actual sales tax paid on motor vehicles, aircraft, boats, mobile homes, and building materials for home construction.

Deductible vs. Non-Deductible Taxes

Foreign Taxes: Credit vs. Deduction

Foreign income taxes receive special treatment—you must choose:

1. Deduct on Schedule A (subject to SALT cap), OR
2. Credit on Form 1116 (dollar-for-dollar tax reduction)

Critical rule: All or nothing per year. If you credit any foreign tax, you cannot deduct any.

In most cases, the credit is more beneficial because it reduces tax directly and is available even with the standard deduction.

Foreign Real Property Taxes — STILL NOT Deductible

TCJA eliminated the deduction for foreign real property taxes (e.g., property tax on a vacation home in another country) for 2018-2025. OBBBA did not restore it; the prohibition remains in effect for 2025.

Exception for Rental Property: Foreign property taxes on a foreign rental property remain deductible as a Schedule E business expense (not subject to the SALT cap).

Personal Property Taxes

Deductible personal property taxes must:

1. Be imposed on an annual basis, AND
2. Be based on the value of the property (ad valorem)

Example: A vehicle registration with a $50 flat fee plus a $200 value-based portion: only the $200 ad valorem portion is deductible.

State Tax Refunds: The Tax Benefit Rule

When a taxpayer receives a state income tax refund, it may be taxable in the year received under the tax benefit rule.

General Rule: A state refund is taxable to the extent the taxpayer received a tax benefit from deducting the state taxes in the prior year.

Three Scenarios:

Scenario 1: Took Standard Deduction Prior Year → State refund is NOT taxable (no tax benefit was claimed).

Scenario 2: Itemized, SALT Below Cap → Refund is fully taxable (full benefit was received).

Scenario 3: Itemized, Capped Out by SALT Limit → Refund is taxable only to the extent of the tax benefit actually received—may be partially or fully non-taxable.

Example (Post-OBBBA Tax Benefit Rule): In 2025, Marco paid $35,000 in state income tax and $10,000 in real property tax—total $45,000. His SALT cap (no phase-down) was $40,000, so he deducted $40,000 and his deduction was limited by $5,000. In 2026 he receives a $4,000 state refund for 2025. Because his $5,000 over-cap amount fully absorbs the $4,000 refund, he received no tax benefit from the overpayment, so the $4,000 refund is not taxable in 2026.

Reporting: Taxable state refunds are reported on Schedule 1, Line 1. Form 1099-G shows the amount.

Schedule A Reporting

Looking Ahead: 2030 Reversion

Absent further legislation, the SALT cap returns to $10,000 ($5,000 MFS) in 2030. EAs should advise high-SALT clients about the temporary nature of the expanded cap.

EA Exam Tips: SALT Deduction (Post-OBBBA)

1. 2025 cap = $40,000 ($20,000 MFS) under OBBBA
2. Phase-down begins at MAGI > $500,000 (30% reduction), with a $10,000 floor
3. Cap inflates 1% per year through 2029; reverts to $10,000 in 2030
4. Income vs. sales tax election still annual—one or the other, not both
5. Foreign income taxes: credit OR deduction (all or nothing)
6. Foreign real property taxes: still NOT deductible on Schedule A
7. Tax benefit rule applies when computing taxability of state refunds, including when SALT cap limited the original deduction
8. Federal taxes (income, FICA, etc.) are NEVER deductible on Schedule A