Ideas & Insights

TAX ALERT: Feds Move to Block SALT Deduction Workarounds

TAX ALERT: Feds Move to Block SALT Deduction Workarounds

One of the most significant, and controversial changes affecting individual tax returns in the Tax Cuts and Jobs Act, H.R. 1 (“the Act”) is the provision limiting the deductibility of state and local taxes (“SALT”), which are now capped at $10,000 for all state and local taxes combined. The limit applies to income taxes, personal property taxes, real property taxes, and sales taxes, which were all previously unlimited itemized deduction. In recent weeks, a turf war has broken out between state legislators seeking to provide a workaround for taxpayers who had previously relied on significant SALT deductions, and federal agencies attempting to block those actions.

States Respond to Limits on SALT Deductions

In the months following the passage of the Act, states with high income tax rates have attempted a variety of tactics to help tax payers circumvent the SALT limitation. New York, New Jersey, and Connecticut have already passed legislation to re-categorize state and local tax payments as charitable contributions, which remain fully deductible. New York’s law also establishes funds for public purposes, which allows taxpayers to make charitable contributions in exchange for a credit against income tax liability.

Connecticut’s tax law seeks a different path by imposing a new income tax on many pass-through businesses at the entity level, which is then offset by a state credit on individual returns.

Other states, including California and Illinois, are considered similar tax law proposals.

The Feds Seeks to Limit Charitable Donations

Earlier this week, the Treasury Department and IRS announced proposed regulations that would block states from sidestepping federal limits on SALT deductions. Notice 2018-54, “Guidance on Certain Payments Made in Exchange for State and Local Tax Credits,” lays out the plan to limit the type of charitable contributions individuals are allowed to deduct on their federal taxes. In effect, the rule would effectively exclude donations that are rewarded with state tax credits.

The Feds are motivated by the tax savings the SALT limitation was intended to supply. Footnote 1 of the Proposed Regulations states: “The Joint Committee on Taxation estimated that the limitation on state and local tax deductions along with certain other reforms of itemized deductions would raise $668 billion over ten years.” These savings are meant to pay for some of the tax cuts that garnered support for the passage of The Act last year. Allowing states to work around the SALT limitation could significantly undermine The Act’s revenue projections.

Further complications emerge when considering how federal authorities will determine “legitimate” charitable contributions, versus those created specifically by states as a SALT limitation workaround. Many states, have pre-existing tax laws that allow taxpayers to get a credit against state taxes for donations to scholarship funds, hospitals, and other charitable organizations. To-date, these donations have been deductible at the federal level.

States Make Their Move

New York, Connecticut, Maryland, and New Jersey, are already in court alleging that the limitation on SALT deductions is an unconstitutional disruption of state taxing powers. With the announcement in Notice 2018-54, several other states are expected to challenge the SALT limitation, which is likely to launch a protracted struggle between states and federal authorities.

What Can Individuals Do This Year?

While the cap on SALT deductions isn’t going anywhere, there are a number of potential workarounds individual tax-payers can consider. Unfortunately, the most obvious is to move your residence, assets or trusts into low tax states. Other solutions are feasible only on a case-by-case basis and require the guidance of licensed tax advisors fluent in both individual tax preparation and the complex SALT laws.

The tax team at MGO is ready to assist you in navigating the SALT deduction limit and other income tax concerns. For further guidance or to schedule a consultation, please contact us.

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