What Does the SALT Acronym Mean in Taxes?

The acronym “SALT” stands for State and Local Taxes. Historically, the federal tax code has allowed taxpayers to deduct certain taxes paid to state and local governments from their federally taxable income. This SALT deduction is intended to prevent double taxation where the same income is taxed at both the federal and state levels.

To use this deduction, a taxpayer must itemize deductions on their federal tax return using Schedule A of Form 1040, instead of taking the standard deduction. The decision to itemize is practical only when the total of all itemized deductions exceeds the standard deduction amount for the taxpayer’s filing status. This feature historically allowed state governments to set tax structures knowing residents could offset some of that cost against federal taxes.

Understanding the SALT Deduction

The SALT deduction covers payments for state and local property taxes and either state and local income taxes or sales taxes. Taxpayers must make a choice between deducting their income taxes or their sales taxes; they are not permitted to deduct both in the same tax year. This choice is influenced by which deduction offers a greater financial benefit.

Real property taxes, such as those paid on a primary residence or land, are eligible for the deduction. Personal property taxes, which some states levy annually on assets like vehicles or boats, can also be included. However, not all payments to local governments qualify, as assessments for specific local benefits like the construction of sidewalks or sewer lines are not deductible.

When choosing to deduct income taxes, taxpayers can include state and local income taxes withheld from paychecks or paid directly through estimated tax payments. Alternatively, to deduct sales taxes, a taxpayer can use the actual amount of sales tax paid by saving receipts from all purchases. A taxpayer can also use an optional sales tax calculator provided by the IRS, which estimates the amount paid based on income and local sales tax rates.

The $10,000 SALT Deduction Cap

The Tax Cuts and Jobs Act (TCJA) of 2017 introduced a cap, limiting the total amount of state and local taxes that a household can deduct to $10,000 per year. For married individuals who file their tax returns separately, this limit is reduced to $5,000 each. This cap applies to the aggregate of property, income, or sales taxes.

This limitation applies to tax years 2018 through 2025. The cap altered the value of the deduction for many, as there was previously no dollar limit. Even if a household pays more than $10,000 in qualifying taxes, their federal deduction is restricted to that amount. Unless Congress acts to extend the provision, the limit will be removed for tax years beginning in 2026.

The impact of the cap is most pronounced for taxpayers residing in areas with high property values and high state income tax rates. For these individuals, the combined total of their property and state income taxes often exceeds the $10,000 threshold. This results in a smaller federal tax benefit than they would have received prior to the TCJA and effectively increases the federal tax liability for many in these states.

State-Level Responses to the Cap

In response to the federal limitation, many states have implemented strategies to mitigate its impact, such as the Pass-Through Entity Tax (PTET). This workaround received clarification from the IRS in Notice 2020-75, which confirmed that these entity-level taxes are not subject to the individual SALT cap.

The concept of a PTET is to shift the payment of state income tax from the individual owner to the business entity itself. This applies to businesses structured as pass-through entities, such as S corporations and partnerships, where profits and tax liabilities pass through to the owners’ personal returns. By electing into a PTET program, the business pays the state income tax on its profits directly to the state.

This payment is then treated as an ordinary and necessary business expense, fully deductible on the entity’s federal tax return without being subject to the $10,000 individual cap. This reduces the amount of taxable income that flows through to the owners. The owners, in turn, receive a credit on their state income tax return for the amount of tax paid on their behalf by the entity, preventing double taxation at the state level.

Navigating Pass-Through Entity Tax Elections

For owners of eligible pass-through entities, participating in a PTET program involves a specific set of actions. Eligibility is restricted to entities taxed as partnerships or S corporations. The process begins with making a formal election with the state’s tax authority, which is an annual and irrevocable decision for that tax year.

The method for making the election varies by state. Some states require the election to be made on a timely filed tax return, while others may require a separate election form to be submitted by a specific deadline, such as March 15 for calendar-year entities. Many states also mandate that the entity make estimated tax payments toward its PTET liability, and failure to meet these requirements can result in penalties.

Once the entity pays the tax, it must be reported on its federal and state returns. On the federal return, the tax is deducted as a business expense. The entity then provides its owners with documentation, such as a Schedule K-1, indicating their share of the state tax credit. The owners use this information to claim the credit on their personal state income tax returns.