One of the most significant, and controversial changes affecting individual tax returns in the Tax Cuts and Jobs Act, H.R. 1 (“the Act”) is the provision limiting the deductibility of state and local taxes (“SALT”), which are now capped at $10,000 for all state and local taxes combined. The limit applies to state income or sales taxes, personal property taxes, and real property taxes, which were all previously un-capped itemized deduction. The SALT deduction limit doesn’t apply to taxes paid in connection with a trade or business or in connection with the production of income. In recent months, a turf war has erupted between state legislators seeking to provide a workaround for taxpayers who had previously relied on significant SALT deductions, and federal agencies attempting to block those actions.
States Respond to Limits on SALT Deductions
In the months following the passage of the Act, states with high income tax rates have attempted a variety of tactics to help taxpayers circumvent the SALT limitation. New York, New Jersey, and Connecticut have already passed legislation to re-categorize state and local tax payments as charitable contributions, which are not subject to the same SALT limits. New York established new “charitable gifts trust funds” to which taxpayers can make deductible contributions and claim a tax credit equal to 85% of the donation. Similarly, New Jersey enacted legislation that permits localities to establish funds to which taxpayers can contribute and receive a 90% New Jersey property tax credit.
Other states, including California and Illinois, are considering or have considered similar tax law proposals.
The Feds Seek to Limit Charitable Donations
Earlier this week, the Treasury Department and IRS announced proposed regulations that would block states from sidestepping the federal limit on SALT deductions. Notice 2018-54, “Guidance on Certain Payments Made in Exchange for State and Local Tax Credits,” lays out the plan to limit the type of charitable contributions individuals are allowed to deduct on their federal taxes. In effect, the rule would effectively exclude donations that are rewarded with state tax credits.
The Feds are motivated by the tax savings the SALT limitation was intended to supply. Footnote 1 of the Proposed Regulations states: “The Joint Committee on Taxation estimated that the limitation on state and local tax deductions along with certain other reforms of itemized deductions would raise $668 billion over ten years.” These savings are meant to pay for some of the tax cuts that garnered support for the passage of The Act last year. Allowing states to work around the SALT limitation could significantly undermine The Act’s revenue projections.
Further complications emerge when considering that many states have pre-existing tax laws that allow taxpayers to get a credit against state taxes for donations to scholarship funds, hospitals, and other charitable organizations. Previous Chief Counsel Advice (CCA) guidance allowed taxpayers a full deduction without subtracting the value of the credit received in return.
States Make Their Move
New York, Connecticut, Maryland, and New Jersey, are already in court alleging that the limitation on SALT deductions is an unconstitutional disruption of state taxing powers. With the announcement in Notice 2018-54, several other states are expected to challenge the SALT limitation, which is likely to launch a protracted struggle between states and federal authorities.
What Can Individuals Do This Year?
While the cap on SALT deductions isn’t going anywhere in the near-term, there are a number of potential workarounds individual taxpayers can consider. Unfortunately, the most obvious is to move your residence, assets or trusts into low or no tax states. Other solutions are feasible only on a case-by-case basis and require the guidance of licensed tax advisors fluent in both individual tax preparation and the complex SALT laws.
The tax team at ELLO is ready to assist you in navigating the SALT deduction and other income tax concerns. For further guidance or to schedule a consultation, please contact us.