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The IRS Announces Plans to Squash SALT Tax Workarounds


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6/3/2018
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The IRS Announces Plans to Squash SALT Tax Workarounds

 

State and Local Taxes (“SALT taxes”) have historically been deductible in full against federal taxable income.  After the passage of the Tax Cut & Jobs Act on Dec. 22, 2017, taxpayers are now limited to $10,000 of total deductions for all itemized deductions.

The IRS has just announced on May 23, 2018 that they plan to attack efforts by New York, New Jersey and Connecticut to avoid federal caps and will issue guidance shortly.  The IRS plans to use income recharacterization and the “substance over form” doctrine to combat workarounds by state governments to preserve SALT tax.  The “charitable contributions in lieu of tax” approach is a strategy that is ostensibly under fire based on the manner of the IRS’s response.  This workaround clearly implicates “substance over form.”  Proposed regulations will likely contain examples that identify strategies of that variety as abusive.

One of the most interesting workarounds comes out of Connecticut.

CT – Small Business Ownership Deduction

Connecticut residents may owe over $600 million in SALT taxes that exceed the $10,000 cap under the new Tax Code.  Connecticut’s Dep’t of Revenue Services calls for an entity-level tax on the net income of passthrough businesses and an offsetting individual income tax credit for all entity members.  Since business taxes aren’t subject to the SALT tax cap, this plan effectively makes individual state taxes into a business deduction, thereby circumventing the federal law.

New York legislators have proposed two plans as workarounds to allow New Yorkers to continue to deduct all of their state and local taxes from federal taxable income. 

S.B. 11, which contains the governor’s proposal, was introduced by four members of Connecticut’s Democratic leadership and is pending in the legislature’s Joint Finance and Revenue committee.

NY - Contribution in Lieu of Tax

New York is exploring creating a state-operated charity to which New Yorkers can contribute in lieu of paying their state taxes.  Charitable contributions are still deductible against federal taxable income without the limitations placed on the SALT tax.

NY - Voluntary Payroll Tax

Essentially, employees could pay 5% of their earnings (over the exorbitant rates already being paid) which would be deductible as an employment tax from federal taxable income, rather than the as a SALT tax.  Many commentators have questioned if this is even would work as a hypothetical since both the tax and the workaround are under the federal umbrella governed by the IRS.

NJ – Municipal Charitable Contribution in Lieu of Tax

On May 4, New Jersey Governor Phil Murphy signed into law a provision (S. 1893) that attempts to allow New Jersey taxpayers to get SALT tax benefits comparable to prior law.

The thrust of the New Jersey approach, which works at the municipal level is that New Jersey is particularly concerned about state property taxes.  Municipal and county governments and school districts can set up “municipal charitable contribution” accounts that taxpayers can pay into, receiving offsetting credits against state property taxes and other municipal taxes owed.

I think any tax lawyer would view the approach as doomed from the outset.  Governor Murphy and those crafting this legislation ignore the very most fundamental aspects of a charitable contribution taught to any first-year law student – a charitable donation is a gift and a donor must not receive anything of value in return.  So, an offsetting tax benefit would be something of value in return.  But, there are other examples that have passed legal muster where all that is being offered is a tax benefit, so there is some precedent there.  It just isn’t very strong.  Ostensibly, federal law, permitting deductions of charitable contributions already violates that rule and that is what bill drafters are banking on.  Nonetheless, a state credit “given in return” for the charitable contribution is a clear quid pro quo, whereas the Tax Code historically simply failed to include those contributions as “taxable income” from a legislative perspective, it did not offer a corresponding credit – which is a horse of a different color.

While some commentators – even Tax Law Professors – back the approach, others point out a fatal flaw is that other contributions to state governments confer a clear state benefit, but the New Jersey law does not, it is simply an excise tax for a proportionate share of state property taxes owed by another name.

https://taxfoundation.org/irs-issue-guidance-clarifying-viability-salt-deduction-cap-workarounds/

https://www.fool.com/taxes/2018/06/02/new-york-becomes-the-first-state-to-pass-a-workaro.aspx

https://taxfoundation.org/new-yorks-new-tax-avoidance-scheme-actually-raise-taxes/

https://www.accountingtoday.com/news/irs-treasury-plan-crackdown-on-state-local-tax-deduction-workarounds



Category: Tax Law


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