The ongoing saga surrounding the new federal limit on individual deductions for state and local taxes is not going away. The Treasury Department recently issued proposed regulations that would effectively kill state programs designed as a workaround to the SALT deduction cap. And there are whispers that controversy surrounding the cap may postpone legislative discussions for technical corrections to the Tax Cuts and Jobs Act until after the upcoming midterm elections.
The Tax Cuts and Jobs Act recently limited the federal deduction for state and local taxes $10,000 for most taxpayers ($5,000 for married taxpayers who file separately). Not surprisingly, Democrat-leaning states with high income tax burdens strongly opposed the inclusion of the SALT deduction cap in the TCJA. Residents in high income tax states bore the disproportionate brunt of the SALT deduction cap, whereas residents in low tax states may be affected far less.
During 2018, several states including New York, New Jersey, and Connecticut passed laws designed as an end-run around the new SALT deduction cap. As we have reported, these laws established a supposedly “charitable” state fund that taxpayers could contribute to in lieu of paying state taxes. Taxpayers making voluntary contributions to the charitable state fund would receive a credit against their state taxes equal to 85-90 percent of their “charitable contributions.”
The IRS, however, responded with an official notice in May 2018 that would disallow federal deductions for “charitable contributions” to the newly-established state funds. Such contributions lack the donative intent characteristic of charitable giving, due to the credit against state taxes received as a quid pro quo for the contribution. Most recently, in July 2018, states led by New York sued the federal government alleging that the SALT deduction cap unlawfully targets them.
The proposed regulations put the Treasury Department and IRS in the middle of political drama. Under the proposed regulations, federal charitable deductions for donations to state funds are allowed only to the extent that the taxpayer does not receive a state tax credit in return. For example, a taxpayer that made a $10,000 donation to the New Jersey fund and received a 90 percent state tax credit of $9,000 could take only a $1,000 federal deduction (the difference between the donation and the credit).
The new rule in the proposed regulations does not apply to state programs where the credit against state taxes is 15 percent or less of donated amount. Still, the new rules could have implications for existing state programs that allow state tax deductions for charitable contributions to hospitals and schools. Experts expect litigation to ensue over these proposed regulations.
TAX REFORM 2.0
Efforts to revamp the Tax Cuts and Jobs Act could be on hold until after the 2018 midterm elections. Viewed as a key Republican victory, the TCJA inspired discussions for additional legislation to make individual and business tax cuts permanent beyond 2025, encourage saving through retirement accounts, and make technical corrections to the TCJA.But controversy surrounding the SALT deduction cap may hold up these discussions for now. Bloomberg Tax is reporting that new tax legislation may not garner enough support to pass without changes to the SALT deduction cap. If the current Congress cannot resolve these issues in 2018, and the balance of power in Congress changes through the midterm elections, then discussions around tax reform could be very different in 2019. Stay tuned.