SALT Limitation Issues

I went into the ITS offices yesterday.  We had a meeting with a client and also it gave me a chance to catch up with the other John.  He attended a tax update workshop last week and we wanted the chance to compare notes.  One thing that caused us a good deal of chuckling is the state and locate tax (SALT) limitation and how it is going to be applied.

Lets say you live in a state that taxes income – say like Oregon.  You make $100,000 a year as an engineer.  You live in a modest home priced at $500,000.

  • Your Oregon income tax withheld is $10,000
  • Your Property tax is $6,500
  • Total SALT is $16,500, capped at $10,000

Oh, but wait.  Your actual Oregon income tax is $9,000 when you finally get to filing the return.

So, lets start with the easy question:

Which part of the $10,000 SALT deduction is the actual deduction?

Why does it matter?  Well, lets start with the fact that you reached the $10,000 limit with your income tax withheld.  If the rule states that you first apply the SALT to income tax and then property tax, your $1,000 overpayment would be taxable income in the next year.  Recovery of a deduction rules.

But if the property tax is deduction first, then you only used $3,500 of your income tax to reach the cap.  So, did you really have a $1,000 overpayment?  Do you still need to recapture that overpayment in the next year?  The state of Oregon is still going to issue the 1099.

Oh wait, how about we pro-rate?  $10,000/$16,500 is (hold on had to dig out the calculator) 60.1%.  So does this mean that you only report 60.1% of the refund as taxable income next year?

Yes, in case you are curious, it seems that the code rewrite is somewhat silent on this trivial matter.  Which means we have to await a ruling from our friends at the IRS.

The same IRS that is getting its budget slashed again for 2018.

Speaking of the IRS, I think the rush to prepay property taxes has been overblown.  There are several problems with all the handwringing but not least of which is, the IRS doesn’t know what your property tax bill is.  This is one of the few items of deductibility where a form is not sent to the IRS.

So, this is going to be an audit issue.  It will most likely start by some enterprising young IRS employee programming an algorithm to look for property tax deductions that are more than 50% higher than the amount deducted in the prior year.  Sounds simple enough.

Nope.  I remember doing some basic research on this wayyyy back in college and there is no such thing as a simple command for the IRS database.  Problem number 1.

Problem number 2.  Assuming they deal with #1 they will send out a ton of notices to people who bought their first home in 2016 and who only deducted a fraction of the property tax.  Knowing the IRS, it will not be a pleasant little letter asking for a reasonable explanation of the deduction and, please disregard if you feel you received this notice in error.  Nooo, it will be a CP2000 notice of deficiency.  Awesome.

Problem number 3.  All these people who got all these notices will send a response back to the IRS.  The IRS computer system cannot read and respond, only a human.  Did I mention that the IRS is getting their budget cut again?  Where are they going to get all these highly trained tax experts who can review a client document and respond effectively?

Look, don’t take this as advice.  Lord knows I don’t want anyone thinking that they can rely upon my little missive to get them out of tax trouble.  But the truth is, anyone who prepaid their taxes is probably safe.  Make sure you have a copy of the check and the payment receipt.  DON’T MAKE IT UP!  If you didn’t prepay it then don’t think you can claim the deduction but if you did, I don’t see the IRS going out of its way to deny the deduction.  It is, after all, a one time deal and frankly…

They need to put their very limited resources into writing the rules to help poor taxpayers figure out how the SALT limitation is going to actually work.  Oh, and rules for every other piece of code section that got put into this major rewrite. The SALT issue is not the worst unknown lurking in this, unfortunately.

Have a great day.  As always, if you would like to discuss this or any other issue feel free to contact me.  And if you are looking for some great tax advice and planning, let me know and let me see what me or my network of great accountants can do for you.

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