Treasury deals final blow to SALT cap workarounds in high-tax states
The Treasury Department dealt the final blow to programs in states like New York and New Jersey designed to help residents circumvent the new $10,000 limit on deductions for state and local taxes.
The regulations, issued Tuesday, prohibit workarounds that would allow residents to create charitable funds for a variety of programs where donors can get a state tax credit in exchange, effectively removing the state and local tax, or SALT, limitation.
The 2017 Republican tax law capped at $10,000 the amount of state and local tax payments that filers could deduct from their federal returns. That change spurred states like New York, New Jersey and Connecticut to find a way to remove the economic pain of the cap, but the Treasury said that most plans gave people too many tax breaks.
Here’s how it worked: A state resident could, instead of paying state property taxes, choose instead to donate to a state-created charitable fund, for example, $30,000. That person would then get to write off the $30,000 as a charitable donation on his or her federal taxes and get a state tax credit for some of that, easing the sting of the lower write-off for their SALT levy.
The new federal regulations say taxpayers can receive a tax write-off equal to the difference between the state tax credits they get and their charitable donations. That means the taxpayer who makes a $30,000 charitable donation to pay property taxes and receives a $25,000 state tax credit would only be able to write off $5,000 on his or her federal tax bill.
“The regulation is based on a longstanding principle of tax law: 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,” the Treasury Department said in a statement.
The regulations formalize a proposal first floated last August to end the workarounds.
The regulations also affect existing programs in many Republican-led, lower-tax states used to fund private education scholarships using the same structure as the Democratic-state SALT workarounds. Alabama, Georgia and Arizona are among states that for years have offered state tax breaks for charitable contributions to funds that raise money for private school tuition.
However, a senior Treasury official said Tuesday that the rules include a provision that give taxpayers the ability to elect to have some charitable contributions to state funds treated as state and local taxes. That would allow taxpayers to claim as much of the $10,000 cap as possible. That change helps equalize the tax treatment for some taxpayers who were disadvantaged in the initial version of these regulations, the official said.
The SALT change was felt most acutely by taxpayers in states where incomes and housing prices are high, places that tend to vote for Democrats. Representatives from those states say Republicans targeted their voters to pay for the tax cut law. House Democrats are working on a plan to increase the deduction limit or repeal it entirely, though any legislative action would likely stall in the Senate.
An IRS official said in March that the agency is also looking at prohibiting other workarounds passed in New York and Connecticut state legislatures that circumvent the SALT cap. The regulations issued Tuesday don’t address other ways to avert the deduction limit.
Connecticut allows owners of so-called pass-through businesses — such as partnerships, limited liability companies and S corporations — to take bigger federal deductions to absorb some of the hit from the SALT deduction limit. New York created a way for employers to shield their employees from the cap.
— With assistance from Kelly Zegers