United States: How to Mitigate the Federal SALT Deduction Limitation Under the New Law

Each state reacts differently to changes to federal tax law. For example, some states automatically conform to federal tax law as soon as legislation is passed. Other states require their legislatures to adopt federal tax law as of a fixed date. This generally occurs on an annual basis. There are some states, however, that pick and choose which federal provisions to adopt.

"Pick and choose" state lawmakers have been very active lately in attempting to mitigate the impact of the newly enacted cap on the deductibility of state and local taxes (SALT). Under the 2017 Tax Cuts and Jobs Act (TCJA), effective for tax years beginning in 2018, taxpayers who itemize their deductions will be subject to a $10,000 cap on state and local individual income, sales and property tax deductions. One way states are using to mitigate the cap on the federal deduction under TCJA is to set up state-operated charitable funds, which is the focus of this Alert.

Although not a significant issue in low-taxed states, this topic has been controversial and impactful in states with higher individual income and property tax rates. Former President Bill Clinton was recently quoted on a national financial television broadcast saying "the [federal] law basically is a bullet aimed at New York and California."

New Jersey became the latest state to attempt to use charitable contributions as a workaround to the new federal limits on state and local tax deductions. On May 4, the Garden State passed a bill that permits municipalities, counties or school districts to establish charitable funds and allow donors to receive property tax credits in exchange for donations and thus sidestep the tax deduction cap.

New Jersey's action occurred shortly after New York's approval of state-operated charitable funds that entitle taxpayers to claim a state tax credit of 85 percent of the donation to healthcare and education funds. The credit appeared in a larger omnibus budget, which included a voluntary payroll tax on employers, another means by which New York attempted to provide some relief to wage earners impacted by the new federal $10,000 limit on the deductibility of taxes paid to states and local governments. 

Additionally, California, one of the first states to act earlier this year, has two bills in process that were referred to the State Assembly. Similar to New York, both bills would allow an individual income tax credit against tax in an amount equal to 85 percent of contributions to the California Excellence Fund.

Illinois also has a similar bill in process. It would permit taxpayers to contribute state and local taxes owed above the $10,000 cap to a state charity, the Illinois Excellence Funds, to receive the credit. The state house approved the bill on April 18, an amended version passed the senate on May 24, and the bill is now back with the Illinois House for consideration.

Other states such as Connecticut and Rhode Island have related legislative action in progress. Connecticut's bill includes the governor's proposal to allow municipalities to establish charitable groups to pay for town services and is awaiting his signature, while Rhode Island's bill is still in committee. State lawmakers are acting with a great sense of urgency to provide taxpayer relief, especially as the mid-term elections loom. Although other states are working on this approach, the chart below presents six states that have actually proposed or enacted legislation.

State

Bill

Highlights

Status

Comments

CA

S.B. 227

For taxable years beginning on or after January 1, 2018, would allow a personal income tax credit against tax in an amount equal to 85 percent of an amount contributed by a taxpayer for the taxable year to the California Excellence Fund.  

Passed Senate January 30; referred to the Assembly Revenue and Tax Committee May 25.

This bill would become operative only if S.B. 581 of the Regular Session is enacted and takes effect on or before January 1, 2019.

 

A.B. 2217

For taxable years beginning on or after January 1, 2019, and before January 1, 2024, would allow a personal or corporate income tax credit against tax in an amount equal to 80 percent of an amount contributed by a taxpayer to a qualified entity from which the taxpayer was transferred Golden State credits.

Passed Assembly May 30; under Senate consideration.

 

CT

 

S.B. 11

Would allow a new revenue-neutral state tax on pass-through entities, which would be offset by a corresponding personal income tax credit. The amount of the new state tax would be a deductible expense on a business's federal income tax return.

Passed Senate on May 8; passed House on May 9; awaits governor's signature.

Substitute bill filed April 5, leaves untouched the governor's proposal to allow municipalities to establish charitable groups that can pay for town services.  

IL

H.B. 4237

Would allow an income tax credit for an amount contributed to the new Illinois Education Excellence Fund during a taxable year. Similarly, a property tax credit would be created for an amount contributed to a county treasury in lieu of property taxes.

Passed House April 18; amended version passed Senate May 24; goes back to House for consideration.

Amended version passed by Senate on May 24 is expected to pass the House. The governor has not announced his position.  

 

H.B. 4563

Would allow residents to donate to I.R.C. § 501(c)(3) foundations supporting public K-12 schools. Donations would be fully tax deductible, provide tax credits equal to the donation amount, reducing state and local tax liability.

Rereferred to rules committee April 13.

 

NJ

S.B. 1893

Permits municipalities, counties or school districts to establish charitable funds and allow donors to receive property tax credits in exchange for donations. Taxpayers could get a credit on their property tax bill of up to 90 percent of the value of the donation.

Enacted May 4.

New Jersey becomes the second state to allow a charitable-contribution credit to mitigate the $10,000 cap on the federal SALT deduction.

 

A.B. 3382

Permits taxpayers to make dedicated prepayments toward anticipated property taxes.

Enacted April 20.

 

NY

S.B. 7509

Permits state-operated charitable funds entitling taxpayers to claim a state tax credit of 85 percent of the donation to healthcare and education funds.

Enacted April 12.

New York becomes the first state to allow a charitable-contribution credit to mitigate the $10,000 cap on the federal SALT deduction.

 

A.B. 9509

Omnibus budget bill; companion to S.B.7509.

Substituted by S.B. 7509.

 

RI

S.B. 2216

Would allow for a credit equal to the amount contributed by a taxpayer for the taxable year to the Rhode Island Ocean State Fund, which is created in the general fund to accept monetary contributions for exclusively public purposes.

Referred to Senate Finance Committee February 1; committee recommended the bill be held for further study May 31.

Creates a fund into which taxpayers could donate money, which the state could spend on public purposes.

 

S.B. 7550

Would allow for a credit equal to the amount contributed by a taxpayer for the taxable year to the Rhode Island Ocean State Fund, which is created in the general fund to accept monetary contributions for exclusively public purposes.

Referred to House Finance Committee February 9; committee recommended bill be held for further study May 8.

 

 

IRS and U.S. Department of the Treasury Reactions

IRS has taken notice of states' proposed and enacted regulations surrounding state charitable funds. On May 23, the IRS issued notice on state and local tax deductions and warned taxpayers to proceed with caution. Notice 2018-54 informed taxpayers that "federal law controls the characterization of the payments for federal income tax purposes regardless of the characterization of the payments under state law." This notice was the first time the IRS has officially weighed in on the matter. Additional warnings included that "[T]axpayers should also be aware the U.S. Department of the Treasury and the Internal Revenue Service are continuing to monitor other legislative proposals being considered to ensure that federal law controls the characterization of deductions for federal income tax filings."

Earlier this year, Treasury Secretary Steven Mnuchin called the state workaround "ridiculous."

TAG's Perspective

We expect similar legislative actions by other states by year-end. We also expect by year-end proposed regulations to help taxpayers understand the relationship between federal charitable contribution deductions and the new statutory limitation on the deduction of state and local taxes. 

The potential federal income tax issue revolves around charitable contribution deductions for which offsetting monetary benefits are received, as well as receiving a deduction for contributions supporting public services that are likewise supported by nondeductible taxes paid by other. In accordance with IRS regulations, taxpayers cannot deduct as a charitable contribution any payment for which they receive a benefit in return.

There may be court challenges. It is also important to note that the state operated charitable fund is one methodology states are reviewing, and, in some cases, enacting. The landscape is changing daily.

As major legislative developments and opportunities emerge, we are always available to discuss the impact of a new or pending tax law on your personal or business situation.

For Further Information

If you would like more information about this topic or your own unique situation, please contact Michael R. Bartosik, CPA, CFP, Steven M. Packer, CPA or any of the practitioners in the Tax Accounting Group. For information about other pertinent tax topics, please visit our publications page

Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.

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