By: Franca Tavella
On June 11, 2019, the IRS issued final regulations that will prohibit taxpayers from using state programs to sidestep state and local tax (SALT) deduction limitations. The SALT deduction, which has been in existence for over 100 years, has historically allowed high-income taxpayers to deduct certain state and local property, income and sales taxes on their federal tax returns without limitation. However, the Tax Cuts and Jobs Act of 2017 capped the SALT deduction at $10,000 per return for single filers, head of household filers, and married taxpayers filing jointly (the cap for married taxpayers filing separately is $5,000). As a result, states with relatively higher tax burdens – such as New York, Connecticut and New Jersey – developed various programs to help their residents circumvent the $10,000 SALT cap. For example, a taxpayer in New York could contribute to a charitable fund created by the State for educational or other purposes in return for a state income tax credit and the ability to separately deduct the entire charitable contribution on their federal tax return.
Unfortunately for those taxpayers, the IRS took steps to end these donation-based workarounds. The final regulations issued by the IRS state that taxpayers can only take a federal deduction equal to the difference between the state tax credit they receive and the amount of their charitable contribution. Thus, if a taxpayer donated $20,000 to the New York charitable fund mentioned above and received a $15,000 state tax credit, he or she would only be able to deduct $5,000 on his or her federal tax return instead of the full contribution amount. According to the Treasury Department, the regulation is rooted in “longstanding principals of tax law” – that is, when a taxpayer receives a valuable benefit in return for a donation to charity, the taxpayer can deduct only the net value of the donation as a charitable contribution. However, the IRS will permit taxpayers to deduct the entire charitable contribution if the state tax credit they received was equal to 15% or less of their contribution.
Looking ahead, the IRS will likely act to prohibit other state workarounds (i.e., those involving pass-through businesses and employers) since the June 11th regulations address only the charitable donation-tax credit workaround.