Californians might retain a state and local income tax deduction — but with limits

Reporting from Washington —  Californians still might retain their ability to deduct state and local taxes from their federal returns under the Republican overhaul — but with a catch.

The total annual deduction would be capped at $10,000, which is the same level as a limited deduction for property taxes that both the House and Senate plans already include.

That cap is only about half the size of the average state and local tax deduction for Californians who claim it.

Republican congressional leaders said that they are considering the change to their tax overhaul legislation as negotiations begin over the final version.

Separate bills that passed the House and Senate both eliminated the state and local income tax deduction, a big blow to many residents of California and other high-tax states.

But the bills retained the deduction for property taxes, subject to the new limit of $10,000. That move came after an outcry from House Republicans from New York and New Jersey, where property taxes make up a larger share of the local tax burden.

House and Senate negotiators now are trying to reconcile the two bills in hopes of enacting the tax overhaul by Christmas.

Some California House Republicans, including Majority Leader Kevin McCarthy (R-Bakersfield), are advocating opening the $10,000 property tax deduction to state and local income taxes to help constituents who claim it.

McCarthy also said he wanted the final tax bill to increase the proposed deduction available for new home mortgages. The House bill would limit the deduction to interest on as much as $500,000 in mortgage debt, down from the current $1-million limit. That change would also be a hit to residents of California and other states with high housing costs.

The new limit would apply to people who bought homes after Nov. 2. The Senate tax bill keeps the $1-million limit. Congressional leaders indicated they are open to increasing the $500,000 figure.

Partially restoring the state and local tax deduction probably would be more costly in terms of lost revenue — no exact estimates were available — but might be needed to secure House approval. In recent days, key lawmakers working on the tax bill indicated they supported expanding the property tax deduction.

“There’s some in the House who would like to see that applied not just to property, but to income tax, you know, where you can sort of pick which state and local tax you want to deduct,” Senate Minority Leader Mitch McConnell (R-Ky.) said Wednesday in a radio interview on “The Hugh Hewitt Show.”

“That sounds like a kind of reasonable idea,” McConnell said.

But the change would be of limited value to many Californians.

The average state and local deduction taken by the 6.1 million state residents who filed for it in 2015 was $18,438, according to the nonpartisan Tax Policy Center. That was the third-highest average of any state, behind New York and Connecticut.

“This potential change may slightly ease the tax burden on a limited number of Californians who itemize their taxes,” State Controller Betty Yee, a Democrat, said in a statement Thursday. “However, the tax bill still largely benefits corporations and the wealthy while leaving working families, the middle class and students to fend for themselves.”

Millions of taxpayers still would be hurt under the compromise, said Americans Against Double Taxation, a coalition including the National Governors Assn., the U.S. Conference of Mayors, labor unions and other state and local government organizations fighting to keep the state and local deduction.

Retaining only a limited property tax deduction, as both bills now do, hurts California more than New York and other high-tax states.

California’s top state income tax rate of 13.3% was by far the highest in the nation last year. The rate in New York and New Jersey was about 9%.

But property taxes in California have been limited since voters passed Proposition 13 in 1978. In an analysis this year of property taxes by personal finance website WalletHub, California tied for the 17th lowest rate. New Jersey had the highest rate.

Californians claimed $70 billion in federal deductions for state and local income taxes in 2014, but only $27 billion in real estate, personal property and other taxes, according to the California Franchise Tax Board.

Times staff writers Lisa Mascaro and Sarah D. Wire contributed to this report.

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