Claiming the State and Local Income Tax Deduction on Federal Taxes

You'll have to itemize, and that might mean paying more than necessary

Expenses Eligible for Deduction as State and Local Income Taxes

Miguel Co / The Balance 2019

Itemizing your deductions means spelling them out in detail to the Internal Revenue Service (IRS) by completing Schedule A and submitting it with your Form 1040 tax return. It can sometimes help reduce your taxable income, but a few tax rules limit some of them. One that's affected is the state and local income tax deduction you can claim on your federal return.

State and local taxes can sometimes be significant, so it's an obvious advantage to be able to deduct the full amount you pay, but that's not always possible. The state and local itemized tax (SALT) deduction lets you deduct up to $10,000 total in combined property taxes and state and local income taxes or sales taxes, but not both.

Rules for the SALT Deduction

All income taxes that are imposed by a state, local, or foreign jurisdiction can be deducted, subject to a few rules. First, you must itemize your deductions on Schedule A to claim them. This means foregoing the standard deduction, which is often more than the total of a taxpayer's itemized deductions for the tax year.

Make sure your itemized deductions, including all other deductions you're qualified to claim in addition to state and local tax deductions, exceed the standard deduction for your filing status, or itemizing will actually cost you tax dollars.

The Tax Cuts and Jobs Act (TCJA) virtually doubled standard deductions for every filing status when it went into effect in 2018, so it might be less likely that the total of all your itemized deductions will exceed these amounts for tax year 2020:

  • $12,400 for single filers and married filing separately
  • $18,650 for heads of household
  • $24,800 for married taxpayers who file joint returns

Also, the tax must be imposed on you personally. You can't claim a deduction for income taxes paid on behalf of one of your dependents—and in some cases, even by your spouse. You must have paid them during the tax year for which you're filing.

Eligible expenses that can be deducted as state and local income taxes include:

  • Withholding for state and local income taxes as shown on Form W-2 or Form 1099
  • Estimated tax payments you made during the year
  • Extension tax payments you made during the year
  • Payments made during the year for taxes that arose in a previous year
  • Mandatory contributions to state benefit funds

2020 Tax Deduction Limits

Unfortunately, the deduction for state and local taxes is no longer unlimited. It used to be that you could deduct as much as you paid in taxes, but TCJA limits the SALT deduction to $10,000, or just $5,000 if you're married but file a separate tax return. This cap applies to state income taxes, local income taxes, and property taxes combined.

For example, you might pay $6,000 in state income taxes and another $6,000 in property taxes for the year. You can't claim the entire $12,000, only the capped amount of $10,000.

This TCJA rule stands through at least 2025 when the law might potentially expire.

Documents You'll Need for Filing

Payments of state and local income taxes can show up on a variety of different documents. Keep copies of your checks or your bank statements showing the debits from your account when you pay estimated taxes to your state or municipality.

State taxes can also show up on various documents related to tax withholding. Keeping a record of all this paperwork will help you maintain a tally of how much you can deduct, up to the TCJA limit. These documents should show how much state or local tax you paid during the year:

  • Form W-2 (Wage and Tax Statement): Shows state income tax withholding in box 17. Local income tax withholding is shown in box 19 and contributions to state benefit funds can be shown in box 14.
  • Form W-2G (Certain Gambling Winnings): Might show state income tax withholding in box 15 and local income tax withholding in box 17
  • Form 1099-G (Certain Government Payments): Might show state income tax withholding in box 11
  • Form 1099-INT (Interest Income): Might show state income tax withholding in box 17
  • Form 1099-DIV (Dividends and Distributions): Might show state income tax withholding in box 15
  • Form 1099-R (Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts): Might show state income tax withholding in box 14 and local income tax withholding in box 17
  • Form 1099-MISC (Miscellaneous Income): Can show state income tax withholding in box 15
  • Form 1099-NEC (Nonemployee Compensation): Can show state income tax withholding in box 5
  • Bank statements with copies of canceled checks or debits can prove estimated payments and after-the-fact payments of state tax.
  • The portion of the previous year's state refund that might have been applied toward estimated taxes.

Year-End Tax Planning

The state income tax deduction can help with year-end tax planning because taxpayers can elect to increase their state tax payments at the eleventh hour to cover any expected state liability that will occur for the year.

For example, you could pay your fourth state estimated tax payment, normally due on January 15, in December. This would boost your itemized deductions and could potentially reduce your federal tax liability for the year.

Check to see if increasing state tax payments at the end of the year will affect your federal return. Taxpayers who are affected by the alternative minimum tax (AMT) will likely find that they receive little or no benefit on their federal return by accelerating state payments. State and local income tax deductions are added back to your taxable income when calculating the AMT.

State and local income taxes are deductible when you're calculating your regular federal income tax, but they're not deductible when you're calculating the AMT.

The IRS has slammed the door on paying estimated property taxes for the following year before year's end in order to claim a deduction in the current year. Those taxes must have been officially assessed as of the date you pay them, and this often doesn't happen until after the first of the year.

The Sales Tax Option

You might consider deducting sales tax instead of the state income tax as an alternative strategy—it's an either/or option. You can claim income taxes or sales taxes, but not both.

This might not change your federal tax liability because the sales tax deduction is also eliminated for purposes of calculating the AMT if you're subject to the AMT. But deducting the sales tax instead can make any state tax refunds non-taxable in the following year.

Special Rules for Spouses

Married couples who file separate returns must both claim the standard deduction or they must both must itemize.

Married taxpayers who are filing joint returns can deduct all state and local income taxes that each of them paid during the year, regardless of whether those tax payments were made separately or jointly, up to $10,000. Married taxpayers who file separate returns can only deduct state and local income taxes paid by them personally, however, up to $5,000.

All income is considered community property if you or your spouse live in one of the nine community property states—Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, or Wisconsin as of 2020. Each spouse must report half of the income on their tax return when they file separately. Deductions are split in half between the two spouses as well.

Article Sources