The Benefits of Prepaying State and Local Taxes

As tax season approaches, many taxpayers are looking for ways to reduce their tax liability while staying compliant with current tax laws. Prepaying state and local taxes (SALT) is one strategy that may offer benefits—but it comes with specific limitations that you need to understand. Let’s break down the basics of prepaying SALT, how it can impact your taxes, and the considerations to keep in mind under the SALT cap.

State and Local Taxes (SALT) include property taxes, state income taxes, and other local taxes. Under the Tax Cuts and Jobs Act (TCJA) of 2017, there is a $10,000 limit ($5,000 for married filing separately) on the deduction of SALT payments. This cap has remained a significant factor in tax planning for individuals in high-tax states.

Why Consider Prepaying SALT?

Prepaying state and local taxes can be advantageous in certain situations, especially if:

You anticipate exceeding the standard deduction: Taxpayers who itemize their deductions may benefit from paying property taxes or estimated state income taxes for the upcoming year before December 31. Doing so allows them to include those payments in their current tax year’s itemized deductions, subject to the SALT cap.

You are subject to Alternative Minimum Tax (AMT): If you’re not subject to the AMT, prepaying taxes can help accelerate deductions. However, those impacted by the AMT won’t see the same benefit because SALT payments are not deductible for AMT purposes.

You’ve had an unusually high-income year: Prepaying SALT can help offset the higher taxable income and reduce the overall tax liability for the year.

Key Considerations When Prepaying SALT

Stay Within the SALT Cap: The $10,000 SALT deduction cap means that any amounts you pay over this limit will not provide additional tax benefits. For example, if you’ve already paid $10,000 in property and state income taxes for the year, prepaying more will not increase your deduction.

Verify State Laws: Some states have created workarounds to the SALT cap, such as pass-through entity (PTE) tax elections. Check whether your state offers these options, as they may provide alternative ways to maximize tax benefits. Consult your tax professional to see if this applies to your situation.

Consider Timing and Cash Flow: Prepaying taxes requires upfront cash, which can impact your cash flow. Make sure that accelerating your SALT payments doesn’t strain your finances unnecessarily. Always balance the tax benefits against your immediate financial needs.

Assess Impact on Estimated Payments: If you pay quarterly estimated state taxes, ensure that prepaying does not result in overpayment or penalties due to underpayment in subsequent quarters. Maintaining accurate records of payments is critical to avoid issues.

To claim a deduction for the current tax year, you must make payments before the year ends. Ensure that you have proper documentation, such as receipts or confirmation of payment, to substantiate your claim.

Prepaying SALT can be a valuable tool for reducing taxable income, but it’s not a one-size-fits-all strategy. Taxpayers in high-tax states, those who itemize deductions, or those with unique income circumstances may find this approach beneficial. However, understanding the SALT cap and working with a knowledgeable tax professional are essential to making informed decisions.

If you’re unsure how the SALT cap impacts you or whether prepaying taxes is the right move, reach out to us at info@mkhstaxgroup.com. Let’s work together to ensure you’re prepared for tax season.