End­ing de­duc­tions might not hurt as badly as some fear

Net Worth

San Francisco Chronicle - - WORLD - 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 pro­pos­als.

Some pun­dits say that elim­i­nat­ing or sharply lim­it­ing the de­duc­tion could doom any bill be­cause Repub­li­cans in high-tax states such as Cal­i­for­nia could not vote for it. In fact, many peo­ple in high-tax states get lit­tle or no ben­e­fit from the so-called SALT de­duc­tion. They fall into three groups:

Non-item­iz­ers: Many low- and mid­dle-in­come peo­ple get no ben­e­fit be­cause they don’t item­ize de­duc­tions. They take the stan­dard de­duc­tion be­cause it’s higher. Both the House and Se­nate tax bills 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 up­per­mid­dle-in­come peo­ple 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. This over­states the ben­e­fit of the de­duc­tion be­cause those num­bers 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 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 of the bills. 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. Un­der the AMT, there are fewer de­duc­tions and 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 Brook­ingsUr­ban 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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