Treasury Blocks SALT Tax Workarounds
Treasury Blocks SALT Tax Workarounds
The Treasury acted last Thursday to block high-tax blue states from passing laws to create SALT tax workarounds. The proposed regulation focuses on charitable contributions, which qualify for a deduction under IRC § 170. Several states, including New York, New Jersey & California have passed laws that attempt to circumvent the removal of the SALT tax deduction by setting up state-run tax avoidance schemes designed to fall under IRC § 170. But, these schemes have a critical flaw that takes them out of “charitable contribution” qualification because they provide a quid pro quo in exchange for the allegedly free gift.
"Congress limited the deduction for state and local taxes that predominantly benefited high-income earners to help pay for major tax cuts for American families," said Secretary Steven Mnuchin in a statement.
"The proposed rule will uphold that limitation by preventing attempts to convert tax payments into charitable contributions," he said.
The regulation slaps down the idea that SALT tax workarounds – voluntary charitable donations to government funds – are legitimate charitable contributions, because the the donor is motivated by the receipt of a benefit, not by philanthropic motives.
The Treasury Regulation notes: “In 1986, the Supreme Court interpreted the phrase “charitable contribution” in Section 170. See United States v. American Bar Endowment, 477 U.S. 105, 116-118 (1986). The Court held that the “sine qua non of a charitable contribution is a transfer of money or property without adequate consideration”— that is, without the expectation of a quid pro quo. Id. at 118. A “payment of money generally cannot constitute a charitable contribution if the contributor expects a substantial benefit in return.” Id. at 116.”
The Treasury Department and the IRS believe "when a taxpayer receives or expects to receive a state or local tax credit in return for a payment or transfer to an entity listed in section 170(c), the receipt of this tax benefit constitutes a quid pro quo that may preclude a full deduction under section 170(a)." Id.
IRS Publication 526, following this same line of reasoning, has long held that taxpayers can’t deduct as a charitable contribution any payment for which they receive a benefit in return.
Tax Foundation analyst Jared Walczak weighed-in on the proposed workaround, stating: “If you’re from Chicago, you can no longer make someone from Birmingham, Alabama, pay for your taxes and cost of living as much as you used to be able to.” This is the “tax fairness” or “parity” argument that high-tax states are essentially forcing their more frugal neighbors to foot the bill for their lavish spending on schools, public services, and the like.
Conservative thinkers and proponents of supply-side economics want to see expenditures for the public good handled by private industry, rather than the government, with all of its inefficiency, corruption, patronage, nepotism and horse-trading. They believe this brings greater accountability and more productive use of capital. This in turn, they believe, produces a fairer system that benefits all.
Liberal thinkers want a government mandate to ensure that priority items like education and law enforcement are insulated from the “free hand” of “market capitalism” and that their funding dollars are set aside and insulated from attack. In part, this is because they believe income inequality and concentration of wealth skew decisions where wealthier individuals would be required to pay part of their wealth for services received by others. They want to preserve redistribution of wealth so that the “haves” cover the shortfall of the “have nots” and everyone enjoys equal opportunities and an even playing field. The government being the referee. Their argument loses force, however, when similarly situated taxpayers face disparate levels of taxation based on nothing more than zip code and the party in power setting expenditure targets in their state or city.
These two political worldviews lead to dramatically different positions relative to state and local taxation. However, high-tax blue states have gone to such an extreme in spending that no one who thinks seriously about the issue can dispute Walczak’s point that there is something fundamentally unfair about someone from Chicago getting a tax break that ends up increasing the tax burden of someone in Birmingham, for no other reason than that Chicago has better schools and charges higher property taxes to fund them. If the Birmingham resident, absorbing a greater proportional share of the tax burden, is also forced to send their child to a school with inadequate resources, one can see why that resident would find average deductions in the range of $20,000/yr in places like New Jersey and Connecticut to be exorbitant. The SALT tax cap does not entirely repeal a break from double taxation for state and local taxes, but caps it at a rate of $10,000.
Under the proposed Treasury rule, deductions for homeowners for State and Local Taxes (“SALT”) are now capped at $10,000. This is a significant change for states like New York, California and Connecticut which have the highest property taxes in the nation.
While reasonable minds can differ on the “fairness” of the SALT tax cap, anyone facing a significantly higher tax bill come April, on either side of the political aisle, can agree that the new law leaves us blue state residents with less money in our pockets. For those of us living in blue states with high property taxes, we are going to feel a big pinch in our pocketbooks now that we are not receiving these deductions.
In New York, new laws created two tax workarounds: (1) a voluntary payroll tax contribution; and (2) charitable contributions in lieu of taxes. Capping the SALT deduction was a change New York Governor Andrew Cuomo said would "destroy" New York.
The New York employee withholding workaround is complex. Employees have their pay reduced in exchange for dollar-for-dollar tax credits to be used in lieu of SALT tax deductions. Employers administer a program that provides an elective withholding tax payment program that employees can receive, and be credited for, against their taxable income, in similar fashion to what was available with the old SALT tax itemized deduction. On July 3, 2018, the New York State Department of Taxation and Finance issued a Technical Services Bureau Memorandum (TSB-M-18(1) ECEP) regarding the implementation of the recently enacted Employer Compensation Expense Program. Tax Law Article 24, Sections 850-857, 606(ccc), 171-a.
“We are confident that the recently enacted opportunities for charitable contributions to New York state and local governments are consistent with federal law and follow well-established precedent,” Cuomo said. “And make no mistake: We will use every tool at our disposal, including litigation, to fight back."
In New Jersey, Gov. Phil Murphy signed legislation to allow municipalities to start "charitable funds" to which residents can donate in return for a 90 percent property tax deduction.
In New Jersey, where high local property taxes are the major issue, local schools and governments have to set up funds through which taxpayers can access the charitable deduction SALT tax workaround. But so far, no towns have notified authorities that they’ve set up funds to receive contributions. The education sector blames the inherent uncertainty in the approach and the fact that state regulators haven’t issued the necessary rules on how to set up these funds.
“In the Trump administration’s rush to punish California they’re now attempting to unilaterally rewrite the law in a manner beyond their authority, and California is prepared to litigate to protect our taxpayers who were unfairly targeted in the GOP tax plan,” said state Sen. Kevin de León (D-Los Angeles).
Assemblywoman Autumn Burke (D-Marina del Rey) proposed a bill that would allow Californians to donate to nonprofits, universities, community colleges or K-12 public school districts, and those entities would transfer 90% of that donation to the state. In turn, the state would lower a taxpayer’s state income tax liability by issuing a state tax credit equal to 80% of the original donation.
Under the Trump Administration, it is clear that the Treasury, lead by Mnuchin, is going to enforce the new tax law as written. Creative attempts to circumvent the law will not be tolerated. State governors and legislatures are on notice, and residents foolish enough to participate in state-run schemes to circumvent the law may be in for a rude awakening when the IRS disallows these deductions and takes harsh enforcement action to boot.
If you are considering participating in a state-sponsored SALT tax workaround, please consult with a competent tax professional before taking on additional potential liability.
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