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A Pinch Of SALT  - The US State & Local Tax Deduction Controversy

Pinch of Salt - The US State & Local Tax Deduction Controversy

Pinch of Salt - The US State & Local Tax Deduction Controversy

On 23 May 2018, the US Internal Revenue Service (IRS) issued Notice 2018-54. In it the agency announced its intention to release new regulations that will likely prevent a federal tax benefit for taxpayers under schemes devised by state governments to enable the circumvention of new limits on state and local tax (SALT) deductions.

The SALT Deduction Cap

Under US tax law, US individual taxpayers are permitted to deduct state property tax payments, and income tax or sales tax payments (but not both), from their taxable income for federal tax purposes. However, the recent US tax reform bill, the Tax Cuts and Jobs Act (TCJA), placed a new USD10,000 cap on these deductions. This limitation applies to taxable years beginning after 31 December 2017 and before 1 January 2026. 

Related: Could The Democrats Tear Up The US Tax Reform Act?

State Workarounds

Some states are heavily opposed to the measure — particularly those whose taxpayers benefited most from the unlimited SALT deduction.

In response, a handful are considering or have adopted legislative measures that would involve taxpayers making transfers to funds controlled by state or local governments. In return, they would receive credits to reduce their state or local taxes — that is, rather than directly paying off their state or local tax liability in the normal way, taxpayers would pay through the fund.

This, the states consider, would enable taxpayers to claim these transfers are charitable contributions, which would be deductible for federal income tax purposes. 

The suggestion is that by paying state tax liabilities through such schemes, the new USD10,000 limit on the value of state and local tax contributions can be avoided.

Related: Finance Industry Braced For FATCA Gross Proceeds Withholding

Notice 2018-54

In its new Notice, the IRS has warned taxpayers that federal — not state — tax law governs whether such transfers are considered to be deductible charitable contributions for federal income tax purposes. It says the Treasury Department and the IRS intend to soon propose regulations regarding the federal income tax treatment of such transfers. The Notice says: “Despite these state efforts to circumvent the new statutory limitation on state and local tax deductions, taxpayers should be mindful that federal law controls the proper characterization of payments for federal income tax purposes.”

The proposed regulations will make clear that the requirements of the Internal Revenue Code, informed by substance-over-form principles, govern the federal income tax treatment of such transfers.



The SALT deduction is one of the most popular deductions permitted by the federal tax code, especially for middle- and high-income taxpayers. For instance, New York residents claimed an average SALT deduction of USD22,169 in 2015, according to the Tax Policy Center. But it was also expensive for governments in revenue terms (uncapped, the SALT deduction would have cost the federal government USD100bn in revenue in 2018, the Tax Foundation has said), and it is seen by many as one of the most inequitable tax breaks in the code.

Related: US Tax Reform - What's In The Final Bill?

The SALT deduction cap will have had a major financial impact on many US-based taxpayers. But while it may be tempting for taxpayers affected by the measure to look to state-mandated solutions to mitigate its impact, with the new federal regulations imminent, an uncertain legal cloud has been cast over such tax planning arrangements.

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