The Treasury and IRS have proposed new regulations that will block high-tax states’ attempts to circumvent the new $10,000 cap on state and local tax (SALT) deductions.
The $10,000 limit on the SALT deduction was part of the Tax Cuts and Jobs Act, an overhaul of the tax code, which was passed last year.
New York, New Jersey and Connecticut — among the states with the highest property taxes — had put legislation in place to help taxpayers bypass the limit on the deduction.
Those plans included permitting municipalities to set up charitable funds and allowing taxpayers to contribute to them. This would allow taxpayers to donate to state-run charitable funds and receive a credit against their state tax bills while also deducting the charitable donation on the Federal income tax return.
However, the Supreme Court has held that a charitable contribution must be a transfer of money or property without adequate consideration. Meaning that there can be no benefit received with these transfers.
Therefore, under the proposed regs, a taxpayer who makes payments or transfers property to an entity eligible to receive tax deductible contributions would have to reduce its charitable deduction by the amount of any state or local tax credit the taxpayer receives or expects to receive. For example, if a state grants a 70% state tax credit and the taxpayer pays $1,000 to an eligible entity, the taxpayer receives a $700 state tax credit. The taxpayer would have to reduce the $1,000 contribution by the $700 state tax credit, leaving an allowable contribution deduction of $300 on the taxpayer’s federal income tax return.
The rule would also not apply for tax credits of no more than 15% of the cash paid to the state. Thus, for example, a taxpayer who makes a $1,000 contribution to an eligible entity would not be required to reduce the $1,000 deduction on the taxpayer’s federal income tax return if the state or local tax credit received or expected to be received was no more than $150.
If you would like to discuss these new regulations in further detail or any other tax planning, please give us a call.