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New Limit on State Tax Deduction Has Employers Thinking

There is little argument that the GOP tax overhaul is the most significant change to the federal tax system in nearly 30 years. Among its many provisions, the law caps the amount of deductible local and state property, income, and sales taxes at $10,000. The limit has some employers wondering how they can help workers avoid what amounts to a tax increase.

Opponents of the plan say that capping state and local taxes at $10,000 means more federal income tax paid on higher taxable incomes. Those in favor of the rule counter by saying that a doubling of the standard deduction more than makes up for it. Who is right depends on each individual taxpayer’s real income. For higher wage earners expecting to see a slight tax increase, there are some options being floated.

Reduce State and Local Taxes

The most obvious fix would be to reduce state and local taxes in those states that are adversely affected by the new limits. Two states that come to mind are New York and California. Lowering state and local taxes in both would be a double benefit by reducing individual tax liabilities and keeping total taxes under the $10,000 mark.

Unfortunately, the easiest and most obvious fix is unlikely to happen. Rarely do states lower local and state taxes, and doing so in response to the GOP tax bill would be an even bigger stretch. Workers in affected states should not expect this fix to be implemented.

Shift the Burden to Employers

Another possible solution is one that some employers are thinking about. It is a fix that involves affected states eliminating state income taxes and, instead, increasing the payroll tax on employers. The same could be implemented with local income taxes.

As the thinking goes, employees ultimately pay all federal and state taxes regardless of whether they are considered employee-side or employer-side taxes. For example, even though employers submit half of the federal FICA liabilities, employees really pay 100% by not otherwise receiving the same amount of money as payment.

Eliminating state income taxes in favor of a higher payroll tax would get around the $10,000 limit while having a minimal impact on employers and employees. From the perspective of the employer, paying the entire tax bill through a higher employer tax is no different than withholding state income tax on behalf of employees.

Workers would not notice any week-to-week changes either. Where they would see a change is in filing their annual tax returns in the spring. Eliminating state income taxes completely removes the state from annual filing obligations. It helps by giving employees more room to claim property and sales taxes up to the $10,000 limit. It also reduces their taxable income by eliminating withholdings that are otherwise subject to the limit.

What It Means to Employers

For the time being, there are no concrete fixes for the local and state tax deduction limits. For employers, nothing changes. They will still be withheld from employee wages and paying state and federal taxes for the 2018 tax year. Any changes to the current system for the purposes of getting around the $10,000 limit will have to originate from state legislation that reduces or eliminates income taxes at the state and local levels.

According to Dallas-based BenefitMall, employers would do well to channel their energies to understanding the new withholding tables the IRS expects to publish by the end of the month. Those new tables tell employers how much to withhold and pay under the reduced tax rates made law by the GOP bill.

About Mark Gabriel

Mark Gabriel

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