As policymakers weigh whether or not to raise or repeal the $10,000 cap on state and native tax (SALT) deductions enacted by the Tax Cuts and Jobs Act (TCJA), they need to wrestle with how that change would primarily profit high-earning taxpayers. As some have identified, different TCJA modifications may further increase the advantages of an uncapped SALT deduction for the highest 5 p.c of filers. Our evaluation illustrates how restoring the SALT deduction now would be extra regressive than below prior legislation, strengthening the case for protecting the cap in place.
Previous to the TCJA, the SALT deduction was topic to a number of limits, together with the person various minimal tax (AMT) and the Pease limitation.
Initially established in 1969, the person AMT is a separate tax system with completely different charges and the next exemption quantity, however fewer tax preferences than the strange earnings tax system. Taxpayers topic to the AMT should calculate their earnings legal responsibility below each the strange tax system and the AMT, after which pay whichever ends in the higher legal responsibility. Most notable for our functions is that the AMT disallows the SALT deduction.
The second restrict on SALT deductions previous to the TCJA was the Pease limitation. The Pease limitation phased out the worth of itemized deductions for high-income taxpayers by 3 p.c for each greenback of taxable earnings above a threshold, which was set at $313,800 for joint filers in 2017. The Pease limitation might cap as much as 80 p.c of a filer’s itemized deductions, together with the worth of the SALT deduction.
The Pease limitation might restrict the worth of the state and native tax deduction, whereas a taxpayer topic to the AMT would lose it outright. Despite the fact that the AMT disallows SALT, AMT taxpayers still benefited from the SALT deduction below the common code as a result of with out it, they’d owe the next tax legal responsibility below the strange earnings tax.
The TCJA paired again the AMT, lowering the number of taxpayers subject to it from about 5 million in 2017 to 200,000 in 2018. The TCJA additionally repealed the Pease limitation for tax years 2018 by way of 2025. Lastly, the TCJA additionally put a brand new restrict of a $10,000 cap on SALT deductions, lowering its worth for a lot of taxpayers.
If Congress decides to repeal the SALT deduction cap now, the AMT and Pease limitation modifications grow to be extra vital. One method to present how the Pease and AMT modifications enhance the advantages of uncapping the SALT deduction is to match uncapping the SALT deduction below present legislation to uncapping it with the prior legislation AMT and Pease limitation in place.
In 2022, repealing the SALT cap below present legislation would supply a 2.8 p.c enhance in after-tax earnings for the highest 1 p.c and a 1.2 p.c enhance for the 95th to 99th percentiles (see desk under).
Combining SALT cap repeal with reinstatement of the Pease limitation and the prior-law AMT considerably reduces these advantages for top earners, leading to a 0.8 p.c enhance in after-tax earnings for the highest 1 p.c and 1 p.c lower for the 95th to 99th percentiles.
The prior-law AMT affected households earning between $200,000 and $500,000 the most, a lot of whom occupy the highest 5 p.c of the earnings distribution. Greater than 70 p.c of taxpayers topic to the AMT earned between $200,000 and $500,000 in 2016.
Filers under the 90th percentile expertise practically no change as a result of they’re much less more likely to be topic to the AMT and the Pease limitation and are much less more likely to itemize their deductions.
|Earnings Quintile||Repeal $10K SALT Cap||Repeal $10K SALT Cap and Impose AMT as below Pre-2018 Regulation||Repeal $10K SALT Cap and Impose Pease Limitation as below Pre-2018 Regulation||Repeal $10K SALT Cap, and Impose AMT and Pease Limitation as below pre-2018 legislation|
|0% to twenty%||0%||0%||0%||0%|
|20% to 40%||0%||0%||0%||0%|
|40% to 60%||Lower than +0.05%||Lower than +0.05%||Lower than +0.05%||Lower than +0.05%|
|60% to 80%||Lower than +0.05%||Lower than +0.05%||Lower than +0.05%||Lower than +0.05%|
|80% to 100%||+1.2%||+0.3%||+0.9%||+0.1%|
|80% to 90%||+0.2%||+0.2%||+0.2%||+0.2%|
|90% to 95%||+0.5%||+0.3%||+0.4%||+0.3%|
|95% to 99%||+1.2%||-0.9%||+1.1%||-1.0%|
|99% to 100%||+2.8%||+1.6%||+1.9%||+0.8%|
|TOTAL||+0.7%||+0.2%||+0.5%||Lower than +0.05%|
Supply: Tax Basis Basic Equilibrium Mannequin, September 2021.
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