Prepaid Property Tax Perplexity Highlights the Tax Code's Confounding Complexity

Even the experts do not know what the law requires.


John Greim/Newscom

Although the tax bill that Congress enacted last week was sold as a simplification measure, it created a bunch of new wrinkles for Americans trying to figure out how much they owe the federal government and why. This week's confusion over prepayment of property taxes shows how even a step in the right direction—in this case, limiting a deduction that favors the wealthiest taxpayers in the most expensive parts of the country—can make the tax code even more complicated.

The tax bill imposed a $10,000 limit on the deduction for state and local taxes (SALT), effective this Monday. The change does not affect most Americans, because most Americans do not pay more than $10,000 in state income taxes, local property taxes, or the two combined. The change does not affect my family, for example, because we live in Texas, which has no income tax, and rent our home, so we have no property taxes to deduct. It would be a different story if we still lived in Virginia, which has an income tax, and still owned a house in Fairfax County, where the median property tax bill is about $5,000. When you add state income tax, a middle-class family can easily pay more than $10,000 total.

In parts of the country with higher home prices and/or higher property tax rates, such as New York City and Los Angeles, the SALT deduction is worth even more. And the bigger and more expensive your house, the more you can expect to save on your federal income taxes (especially when you take into account the deduction for mortgage interest, which the tax bill also limits). The new SALT ceiling therefore makes the tax code less favorable to rich people with mansions (as well as politicians who overtax their constituents). But it also introduces new complications, especially during the transition period.

This week homeowners in places such as Fairfax County, Chicago, Washington, D.C., and Hempstead, Long Island, lined up to prepay their 2018 property taxes before the new limit takes effect. New York Gov. Andrew Cuomo and New Jersey Gov. Chris Christie, who see the SALT limit as an affront to residents of expensive, high-tax states like theirs, encouraged advance payments, while officials in Connecticut said they do not have the legal authority to accept them. The tax office in Simsbury warned that prepayment "could be considered an effort to evade federal income tax liability." Compounding the confusion, the IRS on Wednesday issued an advisory saying prepayments are deductible only if the property tax was officially assessed before the end of this year.

The tax bill specifically precludes deductions under the old rules for prepaid state taxes on 2018 income, but it does not address prepaid property taxes. The IRS did not explain the legal rationale for distinguishing between payments and assessments, which is bound to be the subject of litigation. The upshot is that people who have shelled out thousands of dollars in lump-sum property tax payments may get no benefit from paying early and may not know for sure whether their deductions are valid for months or years. "It's fun if you're a tax lawyer," David Herzig, a professor of tax law at Valparaiso University, told The New York Times. "I'm not sure it's fun if you're a person going through it."

Beyond the economic distortion caused by the tax code's myriad deductions, credits, and exemptions, there is something fundamentally wrong with a system of revenue collection that can be navigated only with the help of experts—and in many cases (like this one) not even then. When it comes to figuring out what the tax code requires, the experts may disagree. People are expected to comply with the law but have no way of determining what that means.