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State and Local Tax Deduction Limit

In Revenue Ruling 2019-11, posted on IRS.gov, the IRS provided four examples illustrating how the long-standing tax benefit rule interacts with the new SALT limit to determine the portion of any state or local tax refund that must be included on the taxpayer’s federal income tax return. The IRS new state and local tax deduction limit announcement does not affect state tax refunds received in 2018 for tax returns.

The Tax Cuts and Jobs Act (TCJA), enacted in December 2017, limited the itemized deduction for state and local taxes to $5,000 for a married person filing a separate return and $10,000 for all other tax filers. The limit applies to tax years 2018 to 2025.

As in the past, state and local tax refunds are not subject to tax if a taxpayer chose the standard deduction for the year in which the tax was paid. But if a taxpayer itemized deductions for that year on Schedule A, Itemized Deductions, part or all of the refund may be subject to tax, to the extent the taxpayer received a tax benefit from the deduction.

State, Local, and Foreign Income Taxes — State and Local General Sales Taxes

State and local income taxes withheld from your wages during the year appear on your Form W-2, Wage and Tax Statement. You can elect to deduct state and local general sales taxes instead of state and local income taxes, but you can’t deduct both. If you elect to deduct state and local general sales taxes, you can use either your actual expenses or the optional sales tax tables. Refer to the Instructions for Schedule A (Form 1040) PDF for more information and for the optional sales tax tables. You may also use the Sales Tax Deduction Calculator. The following amounts are also deductible:

  • Any estimated taxes you paid to state or local governments during the year, and
  • Any prior year’s state or local income tax you paid during the year.

Generally, you can take either a deduction or a tax credit for foreign income taxes imposed on you by a foreign country or a United States possession. For information regarding the foreign tax credit, refer to Topic No. 856 and Am I Eligible to Claim the Foreign Tax Credit?

As an employee, you can deduct mandatory contributions to state benefit funds that provide protection against loss of wages. Refer to Publication 17, Your Federal Income Tax for Individuals for the states that have such funds.

State and Local Real Estate Taxes

Deductible real estate taxes are generally any state or local taxes on real property levied for the general public welfare. The charge must be uniform against all real property in the jurisdiction at a like rate.

There are popular loan programs that finance energy saving improvements through government-approved programs. You sign up for a home energy system loan and use the proceeds to make energy improvements to your home. In some programs, the loan is secured by a lien on your home and appears as a special assessment or special tax on your real estate property tax bill over the period of the loan. The payments on these loans may appear to be deductible real estate taxes; however, they’re not deductible real estate taxes. Assessments or taxes associated with a specific improvement benefitting one home aren’t deductible. However, the interest portion of your payment may be deductible as home mortgage interest. Refer to Publication 936, Home Mortgage Interest Deduction and Can I Deduct My Mortgage-Related Expenses? to see whether you might qualify for a home mortgage interest expense deduction.

Many states and counties also impose local benefit taxes for improvements to property, such as assessments for streets, sidewalks, and sewer lines. You can’t deduct these taxes. However, you can increase the cost basis of your property by the amount of the assessment. Refer to Publication 551, Basis of Assets for more information. Local benefits taxes are deductible only if they’re for maintenance, repair, or interest charges related to those benefits. See Taxes for local benefits in Chapter 11 of Publication 17.

If a portion of your monthly mortgage payment goes into an escrow account, and periodically the lender pays your real estate taxes out of the account to the local government, don’t deduct the amount paid into the escrow account. Only deduct the amount actually paid out of the escrow account during the year to the taxing authority.

Overall Limit for the State and Local Tax Deduction

As an individual, your deduction of state and local income, sales, and property taxes is limited to a combined total deduction of $10,000 ($5,000 if married filing separately). You may be subject to a limit on some of your other itemized deductions also. Please refer to the Instructions for Schedule A (Form 1040) and Topic No. 501 for the limitations.

Conclusion

If you have questions about planning for the state and local tax deduction limits, contact a tax attorney at Disparte Tax Law.