Lawmakers in Congress have made two separate proposals toward tax reform, with the House of Representatives having released its version in early November and the Senate having followed suit shortly thereafter. The provisions of the two proposals aren't identical, but one thing that they share is the elimination of certain key deductions that individual taxpayers have taken for years. One of the most important of those endangered provisions is the deductibility of state and local income or sales taxes, and the potential loss of those deductions has millions of taxpayers upset, especially in states that have particularly high tax burdens. Here, you'll learn exactly how much people benefit from these deductions and what their loss could mean for typical American taxpayers.
What current tax law allows
Under current law, you can take money that you pay to your state or local tax authority for income tax as a deduction. Alternatively, you can deduct the sales taxes that you pay, but you can't deduct both income and sales tax.
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To determine the exact amount you can deduct, you have to take your actual state and local income tax paid. However, those who claim sales tax have a choice: They can either document their spending and deduct the amount of tax paid, or they can use default tax tables that the IRS provides showing average spending and taxation based on income level and state of residence.
Why taxpayers are upset about losing the state and local tax deduction
For those who itemize, the state and local income or sales tax deduction is one of the most popular itemized deductions in the tax laws. Almost 42.7 million taxpayers claimed this deduction on their tax returns in the most recent year for which IRS data is available, and the deductions under the provision amounted to almost $353 billion. That works out to about $8,262 on average for every taxpayer claiming the deduction.
Among those who took the deduction, state and local income tax was a much bigger deal than sales tax. Only 9.6 million taxpayers elected to deduct sales taxes instead of income tax, and their average deduction was just $1,832. By contrast, the 33 million taxpayers who took income taxes as a deduction saved an average of $10,134 from the provision.
Exactly how much that costs the typical family depends on what their marginal tax rate is. Based on current tax brackets ranging from 10% to 39.6%, a deduction of $8,262 would potentially produce tax savings of between $826 and $3,272.
Why the tax plan eliminates the state and local tax deduction
Given the widespread popularity of the state and local income or sales tax deduction, it's somewhat surprising that lawmakers would eliminate the provision. Yet to fit tax reform under budgetary limits, Congress must pay for tax cuts elsewhere by either raising taxes or eliminating existing tax breaks. As part of a package that also includes ending the deductions on real estate and personal property taxes, lawmakers estimate that taxes will rise by $1.3 trillion over the next 10 years.
Politically savvy taxpayers haven't been able to help but notice that the provision would have an outsized impact on those in states with the highest income tax rates. That list happens to include nearly all of the high-population states whose residents voted against President Donald Trump in the 2016 presidential election, including California, New York, Illinois, and New Jersey. Many lawmakers have dismissed speculation that the measure is intended to exact political revenge, but the coincidence is hard to ignore.
Watch your taxes
The tax reform proposals seek to offset the elimination of key itemized deductions by raising standard deduction amounts and providing other breaks for taxpayers. Yet for many, the loss of more than $8,000 in deductions from state and local income or sales taxes will dramatically hurt their chances of actually seeing lower taxes under the proposal. If that happens, Washington can expect a backlash from those it was seeking to help.
This article originally appeared on The Motley Fool.