Limit on state and local tax deduction will hit 11 million taxpayers, Treasury finds

Reporting from Washington —  The new limit on the state and local tax deduction will hit nearly 11 million taxpayers nationwide this year, according to a report by a Treasury Department inspector general.

It is the government’s first estimate of the effect of capping the popular deduction at $10,000, a key and controversial provision in the Republican tax bill championed by President Trump.

An unredacted version of the report released Wednesday also showed that Treasury Secretary Steven T. Mnuchin and other officials last year prioritized halting efforts by California and other states to help residents circumvent the cap.

Deductions for state and local taxes, known as SALT, were unlimited before the Republican tax bill took effect last year. Because of the new $10,000 limit on single and joint filers, Americans will be unable to deduct about $323 billion in state and local taxes that exceed the limit, according to the report by the Treasury inspector general for tax administration.

Many of the 10.9 million filers who will be affected by the cap are in California, New York and other states that tend to vote Democratic. They have higher state income taxes, property values and real estate taxes, all of which fall under the SALT limit.

“This report confirms what many of us always knew to be true: The Republican tax law’s cap on the state and local tax deduction is rattling middle-class families,” said Rep. Judy Chu (D-Monterey Park), lead sponsor of legislation to remove the limit.

Many people in her San Gabriel Valley district are among the affected taxpayers, she said.

Rep. Richard E. Neal (D-Mass.), the new chairman of the tax-writing House Ways and Means Committee, requested the Treasury report and released the unredacted version revealing the role that Mnuchin and other officials played in trying to stop states from providing workarounds for the limit.

A Treasury spokesman declined to comment, but the inspector general’s report said the role played by Mnuchin and other officials was “reasonable” given the “potential impact on millions of taxpayers.”

There was no state-by-state breakdown in the Treasury report. But an analysis by the conservative Tax Foundation found that the deduction allowed Californians to reduce their combined taxable income by $101 billion in 2014 — one-fifth of the total value of the deduction nationwide.

The wealthy reap the most benefits from the state and local tax deduction. But many of the people affected by the cap in California and other high-cost, high-tax states are middle-income earners.

The limit is highly unpopular in states where it hits hard and is a reason why Internal Revenue Service figures show tax refunds are down 16.7% so far this year compared with last year. The main reason, though, are Treasury changes to withholding tables to put more money into workers’ paychecks after the tax bill took effect.

Trump says he’s ‘open’ to changing the cap on state and local tax deductions, but Grassley isn’t »

Bill Forsythe, 57, a hospital radiology technologist in San Jose, said he and his wife were unable to deduct all the $14,000 in property taxes on their home and their state income taxes from their federal return this year. That helped lead to a $9,000 combined state and federal tax bill this year after they had received a $6,000 refund last year.

Not all of the 11 million taxpayers affected by the cap will pay higher taxes, because the law also increased some other deductions along with lowering marginal rates across the board.

But the cap was always viewed as a money-raiser by Republicans, who argued that the deduction disproportionately benefited the wealthy. Democrats said the decision was political, noting that Trump carried only three of the top 10 states for SALT deductions in the 2016 election.

Establishing the cap was a key way to raise additional revenue as part of the Republican tax overhaul, which official government estimates said would increase the federal budget deficit by $1.5 trillion over a decade because of the money lost by slashing rates for businesses and individuals.

The cap will raise about $673 billion over a decade, according to the Tax Foundation.

Elected officials in California, New York and other states tried to provide creative workarounds for residents hit by the limit, such as by allowing people to get credits for charitable donations that offset property tax payments. But the IRS moved quickly to outlaw them.

The inspector general’s report found that the IRS Office of Chief Counsel prioritized issuing guidance to block the workarounds. The IRS proposed issuing a press release announcing the guidance, but Treasury officials decided to issue a formal notice “because it is more authoritative than a press release,” the inspector general’s report said.

The notice was “reviewed and approved by high-level Treasury officials” including Mnuchin, the report said.

The details about the efforts to stop the state workarounds were redacted from the version of the report released Tuesday, which Neal alleged was “clearly in an effort to conceal the process” that the IRS notice “went through and those involved in that process.” He said the involvement of top Treasury officials in a review of such a notice was unusual.

A spokesman for the inspector general, which is an independent watchdog within Treasury, said the parts of the report “containing IRS pre-decisional and deliberative material” were redacted from the public version of the report “in accordance with federal disclosure law.”

The law allows federal officials to withhold from the public such material to allow for “frank internal debate” of sensitive topics, but Neal and Chu decried the redaction.

“The American people have the right to know how decisions regarding a policy of this magnitude is made and who was involved at each step along the way,” Neal said. “Any attempt to hide or conceal that information is deeply disappointing.”