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Friday, December 15, 2017

2018 State Taxes Not Deductible in 2017

Updated 12/27/17: Tax reform has resulted in individuals not able to claim an itemized deduction for all of their state taxes for 2018 through 2025.  The final bill only allows up to $10,000 of a combination of real property taxes and state income taxes (or sales tax in lieu of income taxes). As the bills were progressing through Congress, some practitioners and taxpayers wondered if individuals can prepay their 2018 state income taxes by 12/31/17 and claim a deduction in 2017 before the new law kicks in on 1/1/18.

It seems though that the answer is no.  At 12/31/17, you have no 2018 state tax liability because 2018 hasn't started yet. In contrast, if your property taxes were assessed in 2017 but you can pay them over installments in 2017 and 2018, you can pay the 2018 installment in 2017 and claim the deduction because it is truly a 2017 liability. Also, your fourth quarter estimated payment for your 2017 state income taxes is usually due 1/15/18, but can be paid in 2017. That is still fine and people will want to consider doing so, but must consider the 2017 AMT effect which might result in no tax benefit.  That 4th quarter estimate needs to be reasonable. That is, you can't make a very large 4th quarter payment for 2017 knowing you'll get a refund of it in 2018 (see Revenue Ruling 82-208).

We have AMT in 2017 and for many individuals, they won't get a state tax deduction because they will owe alternative minimum tax where you don't get to deduct your state taxes.

For a great explanation of the tax technical reasons why individuals can't deduct 2018 state tax estimates in 2017, please see the following article by Kip Dellinger and Chris Hesse, CPAs:


"A 2017 federal tax deduction for prepaying anticipated 2018 state income taxes? Not likely!" Journal of Accountancy, AICPA, 12/14/17.

Update: The conference bill and explanation that was released late on 12/15/17 states that state or local income taxes paid in 2017 for 2018 is treated as paid on the last day of 2018. Thus, reminding us that a 2018 state or local income tax is not imposed until 2018. Be cautious if you think this means a prepayment of other state and local taxes for 2018 are deductible in 2017. If the tax is imposed for 2017 but can be paid in 2018, then generally, paying that 2017 in 2017 yields a 2017 deduction (again, don't forget about the AMT effect). The conference and statute language on this is helpful to those who paid 2018 taxes in 2017 because it still allows the cash basis taxpayer to deduct that 2017 payment in 2018 (but with the $10,000 deduction cap for state and local taxes on Schedule A).

Further update: On 12/27/17, the IRS released IR-2017-210 stating that prepaid real property taxes are only deductible in 2017 if assessed and paid in 2017. They provide an example where the county allows property owners to accept prepayments of property taxes for the 20`18-2019 property tax year. But because the tax is not assessed until 7/1/18, the prepayment of 2018 taxes in 2017 is not deductible in 2017.

Hopefully a technical correction can be made to help homeowners who paid their 2018 property taxes in 2017 so they can still deduct them in 2018 even though paid in 2017 (a cash basis taxpayer has to deduct payments (if deductible), in the year paid).

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