What’s old is new again!
At least that is the case for one year-end tax strategy that, for many taxpayers, was neutered after the Tax Cuts and Jobs Act (TCJA) went into effect in 2018. Before the enactment of the TCJA, a common year-end tax-reduction strategy was to pay the fourth-quarter state estimated tax payment before December 31. Doing so allowed taxpayers who itemized deductions to claim the payment in the current year rather than waiting to pay the estimated tax on the due date, which was the following January 15.
However, this planning technique disappeared for many taxpayers beginning in 2018 for two reasons. The first was due to the TCJA increasing the standard deduction for taxpayers, which was larger than the amount of itemized deductions they claimed. Second, the TCJA capped the deduction for state and local taxes (SALT) at $10,000, making early payment irrelevant for millions of households who were already over the cap. These two changes resulted in almost 90% of taxpayers claiming the standard deduction. Even for those taxpayers who still could itemize, prepaying their fourth-quarter state estimated tax payment in December did not help, since they had already maxed out the $10,000 limitation earlier in the year by paying their property taxes or state estimates for the first, second, or third quarter.
However, the recently enacted “One Big Beautiful Bill” (OBBB) changed the landscape significantly—and for the first time in years, many taxpayers once again stand to benefit from accelerating their Q4 state estimated tax payment before year-end.
The OBBB included major adjustments to the SALT deduction rules, effective beginning in 2025. No longer is the SALT cap a hard $10,000 for many taxpayers. There is still a cap, but it is now $40,000. Not everybody can deduct that much. The new law introduced a phaseout once a taxpayer’s Modified Adjusted Gross Income (MAGI) exceeds $500,000. The $40,000 maximum deduction is reduced by 30% of the amount by which MAGI exceeds $500,000. Once MAGI hits $600,000, the SALT limitation cap is $10,000. Taxpayers with MAGI that exceeds $600,000 will still be able to deduct $10,000 of state and local taxes.
Because of the increase in the limitation, a larger share of households will be able to deduct more than $10,000, which could allow those taxpayers to itemize again, especially in higher-tax states.
But before you write that state estimated tax check (or in today’s more modern times, pay the estimate online), you need to be aware of a few things.
The first thing is to determine if you will be eligible to deduct the higher amount. The $40,000 maximum deduction begins to phase out once your MAGI exceeds $500,000. MAGI for purposes of calculating the SALT limitation is your Adjusted Gross Income (total income for the year minus specific allowed adjustments, the most common being taxable IRA contributions, HSA contributions, student loan interest, and some other less common deductions) plus certain add backs such as the foreign income exclusion, foreign housing exclusion, and several other deductions, most of which do not apply to most taxpayers.
If, based on your anticipated MAGI for 2025, you will qualify for the higher maximum limit, the next step is to determine whether deducting the estimated tax payment made in December rather than January will save you more tax this year than paying it in January of next year. For example, if you expect to be in a higher marginal tax bracket in 2026 but still under the $500,000 MAGI phaseout limit, it may make sense not to pay the estimated tax in December but to pay it in January.
A few final thoughts.
Prepaying the fourth quarter estimated income tax only affects your Federal income tax return in terms of lowering your Federal income taxes. State tax laws in states that allow itemized deductions do not allow a deduction for income taxes paid to that state.
We have focused on making the fourth-quarter estimated income tax payment in December, but taxpayers can also prepay their property tax before December 31 and, subject to the phaseout, reduce their Federal income taxes.
The definition of MAGI, the calculation of the phaseout, and the evaluation of which is the better tax year to take the deduction are all complicated and best left to your tax preparer to determine what makes sense.
The changes in the new tax law reopen a valuable year-end planning opportunity. Paying your Q4 state estimated tax before December 31 could meaningfully reduce your 2025 tax bill, but in some cases, the better move may be to wait until 2026.
Please contact us if you have any questions about the strategy.
