The SALT (State And Local Taxes) Conundrum

There have been headlines recently describing the drop in state tax revenues versus forecasts for some of the higher-tax states such as California, New York, and New Jersey. Part of the falloff is due to an exodus of higher-income residents from high-tax states, such as the ones above, for states with low or no income taxes, such as Florida, Texas, and Nevada.

Exacerbating this effect is the SALT provision of the 2017 tax bill (in effect for the 2018 calendar tax year). It puts a $10,000 cap on the amount of deductible state and local income taxes and local property taxes. This cap, of course, effectively raises the effective rates of these taxes by an amount equal to the loss of deductibility.

Prior to this year, being able to deduct state and local taxes in full meant that taxpayers subject to the old 39.6% highest marginal tax rate effectively wrote off almost 40% of their taxes. The SALT change means that, on a cash-flow basis, both people’s property taxes and income taxes will effectively rise almost 40% from what they paid last year. Here’s an example. Let’s say a New Jersey couple paid $30,000 in property taxes and $30,000 in state income taxes. Under the old method, their $60,000 would be reduced to $36,180 as they would have written the tax off at 39.7%, the old top federal marginal rate. Under the new method, state and local taxes are not deductible, except for the $10,000 limit. Thus, their new taxes are $50,000 ($60,000-$10,000), or 38% more.

For obvious reasons, this new tax bite has generated much consternation and many crosscurrents.

Muni Bond Standpoint
Some of the best-performing bonds in the past two years have been higher-grade issues from New York, California, New Jersey, and Connecticut. We have written on this effect, and we began to emphasize these bonds even in national accounts in the middle of 2017. As the tax bill was being discussed, it became evident that SALT was going to be part of the package. It meant that income from out-of-state bonds for taxpayers in high-tax states would have to overcome a higher yield threshold since more would be taken away by the non-deductibility of state and local taxes on a Federal return.

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Disclaimer: The preceding was provided by Cumberland Advisors, Home Office: One Sarasota Tower, 2 N. Tamiami Trail, Suite 303, Sarasota, FL 34236; New Jersey Office: 614 Landis Ave, Vineland, NJ ...

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