Itemized Deduction for State and Local Taxes

December 20, 2017

This is the first in our series Last Minute Actions for the New Tax Law.

The new tax law will make it harder to benefit from itemized deductions for state and local tax, partly because of an increase in the standard deduction and partly because of a new limit on this particular deduction. Affected taxpayers may want to consider prepaying tax they otherwise would pay in 2018, but the law appears to block this strategy as to prepayments of state and local income tax.

Standard deduction. Taxpayers claim itemized deductions only when they exceed the standard deduction. Under prior law, a married couple with $20,000 in deductions such as charitable contributions, mortgage interest, and state and local taxes would itemize rather than claim the $13,000 standard deduction. Under the new law, this couple will claim a $24,000 standard deduction — and obtain no tax benefit from the payments they would have claimed when itemizing. It’s estimated that roughly half the people who itemized under prior law will now claim the standard deduction.

$10,000 limit. Beginning in 2018, the amount that can be claimed as an itemized deduction for state and local taxes may not exceed $10,000. Therefore, even if your deductions are large enough to justify itemizing after this hefty increase in the standard deduction, your claim for state and local tax payments may be sharply curtailed.

Tax payments deducted on forms other than Schedule A are not affected (for example, real property tax paid on a residential rental property). Similarly, the deduction for foreign income tax is not subject to this limit. By contrast, the itemized deduction for foreign property tax is eliminated; taxpayers may no longer claim this item even if it would fit within the $10,000 limit.

Prepaying taxes

An obvious end run would be to pay a fourth quarter estimate for state and local income tax in December 2017, increasing the check to a size that will produce an overpayment large enough to cover tax you’ll owe for 2018. Congress anticipated this possibility and included a provision designed to block it. State and local income tax paid in 2017 for a later year will be treated as paid on the last day of the year for which the tax is imposed.

That doesn’t mean you’re entirely blocked from taking action. For one thing, unless you’ve already fully paid your state and local income tax for 2017, you should pay a fourth quarter estimate by the end of the year. There’s nothing wrong with paying in December an amount that would otherwise be due next January 15 or April 15, so long as it pertains to tax imposed for 2017.

What’s more, this special rule applies only to prepayments of state and local income tax. Prepaying property tax could be a viable strategy if you’re in a position to do so. If you deduct sales tax instead of income tax, a new car bought in December 2017 may offer a tax benefit not available if the purchase happens after the first of the year.

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