This week, we look at the push and pull that the federal tax system inflicts on state and local tax systems.
Before Trump’s first term, people who had to pay state-specific taxes, such as state income tax or real property tax, could write off those taxes as an itemized deduction.
The Tax Cuts and Jobs Act in Trump’s first term introduced a hard cap of $10,000 on the state and local tax (SALT) deduction ($5,000 for married taxpayers filing separately). Because of the much higher standard deduction enacted at the same time, most Americans didn’t feel the pain. Those that did tended to be either higher income people; residents of blue states (which tended to impose higher personal income taxes); or owners of businesses that were run out of LLCs, S corporations, or partnerships because those entities didn’t pay income taxes but rather passed through their income to their owners, who then had to pay taxes on that income (which is why we call such entities “pass-through entities”).
Folks in the blue states, such as California and New York, started complaining, and some of these states enacted workarounds that would let a pass-through entity pay state income tax by itself without waiting for the owners to pay. The pass-through entity was not an individual, so it escaped the $10,000 cap. The IRS gave its blessing to the workarounds. Hawai‘i became one of several states to enact this kind of workaround.
So, what did the One Big Beautiful Bill Act do?
First, it raises the $10,000 cap to $40,000. But there are catches. First, the additional breathing room is only temporary, from 2025 through 2029. The $10,000 cap returns in 2030. Second, there is a phaseout. For taxpayers with modified adjusted gross income of $500,000 or more, the threshold is reduced by 30% of the amount of income over the threshold. The same threshold is applied for joint returns. A taxpayer couple making $550,000, therefore, would have their $40,000 cap reduced by $15,000 (30% of $50,000, the excess over $500,000) to $25,000. Taxpayers with MAGI of $600,000 or more have a cap of $10,000 because the phaseout doesn’t reduce the cap below $10,000. For years 2026 through 2029, the cap and the phaseout threshold are both increased by 1% per year.
What about the state law workarounds that we previously described? Those still work. Although previous versions of the OBBBA contained provisions that would have made the workarounds ineffective, those provisions did not make it to the final bill.
What about sole proprietors operating a business out of a LLC owned by a single member? They continue to take it on the chin. The workarounds typically do not apply to single member entities because the entities are disregarded, or treated as if they don’t exist at all, for income tax purposes. Thus, the income tax paid on the business is considered paid by the individual owner even if the business entity pays the tax.
And what about businesses that pay taxes like sales tax, lodging tax, or Hawai‘i’s General Excise Tax? As before, the businesses can deduct such taxes without limit. Those taxes are deducted on Schedule C, E, or F. The SALT limit is applied on Schedule A.
And what about Hawai‘i income tax consequences? We do not yet know what they are going to be. The Legislature will figure that out in the 2026 legislative session which starts in January. For now, Hawai‘i income tax law departs from federal law on this point and does not recognize the federal SALT cap at all. Thus, Hawai‘i income tax returns that are prepared now don’t have to take any SALT cap into account.
Tom Yamachika is president of the Tax Foundation of Hawaiʻi. Reprinted with permission.
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