Fixing the SALT $10,000 Cap

Source: JCX-35-19 (6/24/19) for the House Ways and Means Committee hearing on problems with the SALT cap.

On June 25, 2019, the House Ways and Means Committee held a hearing on the SALT cap with the majority's views on it clear from the title of this hearing: How Recent Limitations to the SALT Deduction Harm Communities, Schools, First Responders, and Housing Values. Testimony was provided by some state and local elected officials and the Tax Foundation.

I agree that this is a flawed provision that was addressing what was already a flawed provision. There were no hearings held for the Tax Cuts and Jobs Act so it was difficult to get broad input into the process.  The AICPA Tax Section did submit a few letters during this process including one that made a very important point. If individuals would have a cap on their state and local tax deduction when claimed as an itemized deduction, an additional change had to be made to treat all business entities the same. Since a C corporation continues to get to deduct all of the state and local income taxes it pays, so should a sole proprietor, partner and S corp shareholder. That could have been accomplished by making a change to a 1944 law to allow state and local income taxes on that business income to be deducted above the line (for AGI) rather than only as an itemized deduction. [See AICPA letter of 11/21/17 and letter of 9/25/18 submitted when the House was discussing Tax Reform 2.0]

My observations regarding the policy of deducting state and local taxes:

1. There should be equity among different types of business types (see above paragraph).
2. Prior to the TCJA, only 30% of individuals itemized deductions and many of these folks lost their SALT deduction due to owing AMT. Thus, this was not a widespread deduction.  Many elected officials including governors of New York and New Jersey have issued statements since the change was introduced in fall 2017 that make it sound as if all of their residents are losing a big deduction. But, again, prior to the TCJA, less than 30% of individuals deducted their personal SALT.
3. Why allow a deduction for state and local taxes not related to a business? After all, there are lots of personal expenditures we can't deduct such as car insurance, 100% of child care, 100% of tuition, and lots more. Well, one argument is that you must pay state and local taxes so it does represent dollars not available for paying federal taxes. But, this is not completely true.  For example, if Jane decides to buy a large home for $1 million rather than a modest one representing the median home value in Jane's area of $300,000, she will owe more property tax. Should she be allowed to deduct property tax on the $1 million home which is far above the median home price in her area?
   
   Bear in mind that special tax rules (deductions, exclusions, credits and favorable lower tax rates) reduce someone's taxes with the "cost" borne by others.  Why should others bear the cost (tax deduction) of Jane's decision to buy a more expensive home than the median home price. A great example of an extreme on this is evidenced by Mitt Romney's return for 2011 showing he paid property taxes on his personal residences of $214,728.  I'm not singling him our to pick on him, it is just that his return is publicly available from when he ran for President and voluntarily disclosed it. Many high income/high wealth individuals own multiple homes of high value and thus pay a lot of property tax. Many of these high income individuals also used to get a full deduction for these taxes before the $10,000 SALT cap because their regular tax rate was high enough to not be subject to AMT. [Thanks to Tax Notes (and the candidates and elected officials) for making these returns available to the public.]
   
   Note: Limit or repeal of the SALT deduction is not new. It was addressed in Treasury's 1984 Blueprint for Tax Reform which led to the Tax Reform Act of 1986 and repeal of the sales tax deduction. For more, see my May 2008 article - here.
4. Repeal of the SALT cap will provide a significant benefit to high income individuals. After all, it's a deduction and bigger deductions reduce taxes the most for individuals in high tax brackets. Per data from the Joint Committee on Taxation released for the June 25 hearing (JCX-35-19, Table 4), for 2019, repeal of the $10,000 SALT cap would reduce individuals' taxes by $77.4 billion with $40.4 billion of this savings going to individuals with income over $1 million (less than 0.5% of the public). All told, $73 billion or 94.3% of the benefit would go to individuals making over $200,000 of income.

It is puzzling why so much attention is being paid to repealing the $10,000 SALT cap (and mostly from Democrats who tend not to be fighting for additional tax cuts for high income taxpayers), rather than taking a policy perspective to reforming this flawed deduction and cap.  And better yet, why not look at other weaknesses in our tax system as well, and work to fix them, with the result that we'd have a more understandable (simpler) and equitable system, most likely with lower rates.

I suggest that for fairness and equity and better ability to keep rates low, as part of reform of the SALT cap that it be replaced with a cap on Schedule A property taxes to only allow a deduction for property taxes on a principal residence costing 110% of the median home price for the area. In addition, state and local income taxes attributable to business income should be deductible above the line (for AGI) just like a C corporation is allowed to do. Property taxes on business property (including rental property) would continue to be deducted above the line as they have been in the past (and still today). And the individual AMT should be repealed so there is just one set of rules rather than two with two tax calculations.

What do you think?