Post-Wayfair, sales tax seems like the only thing anyone in State & Local Tax ("SALT") is talking about.  But the Tax Cuts and Jobs Act of 2017 ("TCJA") – Congress' colossal federal income tax overhaul – ushered in another momentous change in the relatively stable world of SALT that deserves our attention.  Prior to the TCJA, taxpayers who itemized deductions could deduct the full amount paid in state-level income, property, real estate, and sales taxes on their federal income tax return.  Under the new tax law, that deduction is capped at $10,000 for single and married taxpayers filing jointly ($5,000 for married taxpayers filing separately).  For high-earning taxpayers living in mid-to-high-tax states, the SALT deduction cap makes a significant difference.

Several states, such as New York, New Jersey, and Connecticut, have gotten creative in their efforts to protect their residents from the fallout of the SALT deduction cap by starting charitable funds that benefit certain programs and initiatives.  In these states, taxpayers who make donations to these funds receive a state tax credit in addition to a federal charitable deduction.  Fundamentally, the new federal income tax law directly impacted state tax policy; the states reacted by building a workaround, giving up a bit of their own revenue in the interest of keeping their wealthy residents from fleeing to other states with lower tax rates.

Of course, the federal government isn't interested in footing the bill for the charitable deductions generated by the states' clever workarounds.  After all, a tax deduction by any other name still costs money.  In an impressively rapid response, the U.S. Department of Treasury issued new regulations last week limiting charitable deductions to the portion of the charitable donation that exceeds the state tax credits received.

The "charitable fund" structure isn't the only workaround attempted by state legislatures.  Several states have imposed a tax on the income of pass-through entities, which can then be offset in the form of a credit, deduction, or exclusion on the owner level.  Whether these arrangements pass muster is yet to be seen, but we can be sure that "top men" are looking into it.

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