End­ing de­duc­tions might not hurt as badly as some fear

San Francisco Chronicle Late Edition - - NEWS - Kathleen Pen­der is a San Fran­cisco Chron­i­cle colum­nist. Email: kpen­der@sfchron­i­cle.com Twit­ter: @kath­pen­der

The item­ized de­duc­tion for state and lo­cal taxes has be­come a flash point in the de­bate over the GOP’s tax plans.

The House and Se­nate pro­pos­als call for sharply lim­it­ing or elim­i­nat­ing the so-called SALT de­duc­tion. Crit­ics say Repub­li­cans in high-tax states would have a hard time vot­ing for any bill that in­cluded this pro­vi­sion, be­cause the de­duc­tion is so valu­able to their con­stituents.

And it is, to some. But many peo­ple in high-tax states get no ben­e­fit from this de­duc­tion be­cause they don’t item­ize de­duc­tions or they are sub­ject to the al­ter­na­tive min­i­mum tax, which doesn’t al­low it. An­other group of peo­ple get lit­tle ben­e­fit be­cause they are sub­ject to the phase­out of all item­ized de­duc­tions that kicks in at higher in­comes.

A study pub­lished Tues­day by the In­sti­tute on Tax­a­tion and Eco­nomic Pol­icy pre­dicted that

four states in­clud­ing Cal­i­for­nia “would see their res­i­dents pay

more in ag­gre­gate fed­eral per­sonal in­come taxes un­der the House’s Tax Cuts and Jobs Act,” largely be­cause it would “dra­mat­i­cally cur­tail” the SALT de­duc­tion. But that doesn’t mean ev­ery­one in Cal­i­for­nia would be hurt by the loss. Here’s a closer look at three groups for whom it would not mat­ter much, if at all. Non-item­iz­ers: Many lowand mid­dle-in­come peo­ple get no ben­e­fit from the SALT de­duc­tion be­cause they don’t item­ize de­duc­tions. They take the stan­dard de­duc­tion be­cause it’s higher. Both the House and Se­nate tax pro­pos­als would in­crease their ranks by roughly dou­bling the stan­dard de­duc­tion to $24,000 for mar­ried cou­ples fil­ing jointly and $12,000 for sin­gle fil­ers. The Tax Pol­icy Cen­ter es­ti­mates this would re­duce the share of all tax fil­ers who item­ize to less than 10 per­cent from about a third to­day. AMT sub­jects: Some peo­ple, mostly up­per-mid­dle-in­come, get no ben­e­fit from the de­duc­tion be­cause they are sub­ject to the al­ter­na­tive min­i­mum tax. Un­der the AMT, state and lo­cal taxes — in­clud­ing in­come, sales and prop­erty taxes — are not de­ductible. Most peo­ple who owe AMT earn around $200,000 to $500,000. In Cal­i­for­nia, about 5 per­cent of all tax re­turns paid AMT. Only New Jer­sey, Washington, D.C., Con­necti­cut and New York had a larger per­cent­age. Pease peo­ple: Some high­in­come peo­ple who item­ize de­duc­tions and are not in the AMT lose some of the de­duc­tion through what’s known as the Pease lim­i­ta­tion. This pro­vi­sion eats away at a tax­payer’s item­ized de­duc­tions — in­clud­ing the one for state and lo­cal taxes — once tax­able in­come hits $330,000 (mar­ried fil­ing jointly) or $266,700 (sin­gle fil­ers). It can de­vour up to 80 per­cent of item­ized de­duc­tions. Both the House and Se­nate ver­sions of the GOP tax bills would re­peal the AMT and the Pease lim­i­ta­tion.

The Se­nate ver­sion would do away with the state and lo­cal tax de­duc­tion en­tirely. The House ver­sion would do away with the de­duc­tion for state and lo­cal in­come or sales tax but let item­iz­ers deduct up to $10,000 in prop­erty taxes.

In Cal­i­for­nia, about 34 per­cent of 2015 tax re­turns claimed a SALT de­duc­tion, and the av­er­age among those who did was about $18,400. Th­ese of­tencited num­bers over­state the ben­e­fit of the de­duc­tion be-

cause they in­clude peo­ple who claimed the de­duc­tion on their re­turn but lost all or part of it be­cause of the AMT or Pease lim­i­ta­tion.

The in­ter­ac­tions among the AMT, SALT and Pease lim­i­ta­tion “have gen­er­ated con­sid­er­able con­fu­sion, as it can ap­pear that cer­tain tax­pay­ers would ‘lose’ the state and lo­cal tax de­duc­tion when, in fact, they can­not claim it un­der cur­rent law due to the AMT, or can only claim a por­tion of it due to the Pease lim­i­ta­tion,” the Tax Foun­da­tion, a re­search or­ga­ni­za­tion, said in a blog post.

For peo­ple sub­ject to AMT, killing the AMT and SALT de­duc­tion could re­sult in higher, lower or roughly the same taxes, de­pend­ing on their in­di­vid­ual cir­cum­stances and other pro­vi­sions in the tax pro­pos­als. Here’s why:

All tax­pay­ers are re­quired to fig­ure out their taxes un­der the reg­u­lar tax sys­tem and the al­ter­na­tive sys­tem and pay which­ever is higher. Un­der the reg­u­lar sys­tem, there are seven tax brack­ets, top­ping out at 39.6 per­cent. The AMT al­lows fewer de­duc­tions and has only two tax brack­ets, 26 and 28 per­cent.

The high­est-in­come peo­ple gen­er­ally do not pay AMT be­cause their reg­u­lar tax rate, 39.6 per­cent, is so much higher than 28 per­cent.

When peo­ple are sub­ject to the AMT, it shows up on their tax re­turn as an ad­di­tion to their reg­u­lar tax.

In June, the Brook­ings-Ur­ban Tax Pol­icy Cen­ter es­ti­mated what would hap­pen if Congress killed the SALT de­duc­tion and the AMT. It found that nearly three-quar­ters of AMT fil­ers would pay higher taxes, mainly be­cause their reg­u­lar tax with­out the SALT de­duc­tion would be higher than their AMT. The other quar­ter would see a tax cut.

This analysis, how­ever, did not fac­tor in a cut in reg­u­lar tax rates. Both the House and Se­nate tax bills would cut mar­ginal tax rates for most tax­pay­ers, which prob­a­bly would re­duce the per­cent­age of AMT fil­ers who might get hurt by the loss of the SALT de­duc­tion.

The cen­ter did not es­ti­mate how the bills would af­fect peo­ple cur­rently sub­ject to AMT. But it did es­ti­mate the im­pact of the orig­i­nal House bill on tax­pay­ers in gen­eral and found that in 2018, about 76 per­cent would get a tax cut and 7 per­cent would get a tax in­crease. For peo­ple in the top 95th to 99th in­come per­centile, 6 per­cent would get a tax in­crease. Those tend to be AMT peo­ple, said Frank Sam­martino, a se­nior fel­low with the cen­ter.

The Tax Foun­da­tion had a dif­fer­ent take. “For tax­pay­ers de­nied the SALT de­duc­tion cur­rently, re­plac­ing the over­all de­duc­tion with a capped prop­erty tax de­duc­tion, paired with the re­peal of the AMT and the Pease lim­i­ta­tion, ac­tu­ally rep­re­sents a mod­est ben­e­fit, not a loss,” it said in a blog post.

Bot­tom line, take what you hear about the state and lo­cal tax de­duc­tion with a grain of salt.

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