As promised, the IRS has countered state attempts to create SALT deduction limit workarounds in proposed regulation amendments. Earlier this year, the IRS advised it would address payments by taxpayers to state and local charitable funds. Reaction on Capitol Hill and from tax policy experts is mixed.
What Are The New Federal Limits?
Beginning in 2018, an individual’s federal itemized deduction of state and local taxes is limited to $10,000, or $5,000 if married filing separately.
The limits were part of the Tax Cuts and Jobs Act enacted in 2017.
What Are The State Workarounds?
After the deduction cap was enacted, some states adopted laws allowing tax credits for contributions to funds controlled by the state and local government. These laws attempt to get around the limit by creating payments that would be a charitable contribution deduction under federal law.
New York: Income Tax Credit
For taxpayers making a donation to certain charitable contribution funds, New York provides an income tax credit equal to 85% of the donation amount. The credit is available for tax years beginning after 2018.
New Jersey: Property Tax Credit
New Jersey enacted a law allowing taxpayers to donate to a charitable fund established by their city, county, or school district. In return for their donation, the taxpayer receives a credit on their property tax bill of up to 90% of the donation.
Connecticut: Property Tax Credit
Under Connecticut’s provision, municipalities can give a property tax credit to taxpayers who make contributions to a community supporting organization.
What Would The IRS Regulations Do?
The IRS takes the position that federal law controls when determining charitable contribution deductions for federal income tax purposes.
Under the proposed regs, receiving a state and local tax credit for a charitable contribution would amount to receiving a return benefit. Thus, a taxpayer must reduce any federal charitable contribution deduction if they:
- make a contribution to a charitable entity; and
- receives a state and local tax credit in return.
Exception under the Regulations
The proposed regulations contain two exceptions.
One exception is for dollar-for-dollar state tax deductions.
The other exception is for state tax credits equal to 15% or less of:
- the payment amount; or
- the fair market value of the property transferred.
New York To Consider Legal Action
New York indicated that it will consider legal action in response to the proposed regulations.