Reducing SALT Pain
Annually, thousands of professionals use their own artistry and originality to find the best ways to decrease your federal taxes. You know you’re living in new times when state lawmakers are added to the mix.
The reason they’re putting in so much effort is something popularly called the SALT provisions of the new Tax Cuts + Jobs Act — which sets a $10,000 cap on the deductibility of state and local income tax. That limit isn’t a major deal for residents of Texas or Florida, as well as other states that do not collect income taxes. But people living in New York, New Jersey, Connecticut and California generally pay far more than $10,000 into their state, in addition to the property and municipal taxes.
Those higher-tax areas are now using the above originality and artistry to aid their taxpayers to reclaim those deductions — and some of these proposed solutions are indeed quite creative. For example, New York has recently started to allow taxpayers to, instead of paying their local property taxation, simply make a corresponding charitable donation to a charity set up from their regional school district. Presto! What used to be a tax would now be a charitable contribution that becomes deductible for taxpayers who itemize. The state would also allow New York City as well as other municipalities to establish their own charitable trusts, converting local taxation to deductible charitable contributions.
To not fall behind, New Jersey and Connecticut are trying to reclassify state taxes as charitable donations, while the Empire State plans to allow taxpayers to convert their own state income tax to a payroll tax, which their employers would pay for them — and then deduct that from their federal tax bill.
Thinking even further out of the box, California’s Senate Bill 277 would introduce something called the “California Excellence Fund,” which would offer a credit against state income tax liability for any donations to the fund — effortlessly recharacterizing just as much of this state tax liability as the resident needs into allowable charitable contributions. Similar legislation has been put forward in Illinois, Nebraska and Virginia. In Washington state, which will not impose an income tax, a copycat bill would let taxpayers create charitable donations to the state and receive a sales tax exemption certificate in return.
The most detailed fix is being proposed in Connecticut, whose legislature is finishing up a bill which will charge an “entity-level” tax on pass-through businesses like Subchapter S corporations and LLCs. These entities are only taxed at the shareholder level (hence the name “pass-through”). Those entity-level taxes could be deductible by the S corp. or LLC, and the state would issue an offsetting individual tax credit to entity shareholders. The state tax becomes deductible at the entity, and the individual’s state income tax obligation goes away. Connecticut’s Department of Revenue estimates that the provision will regain $600 million in otherwise-lost SALT deductions for state residents from the very first year alone.
Is any of this legal? In all honesty, we’re not quite sure yet. The IRS has recently issued a caution against states’ creative use of charitable contributions, plus it never helps when lawmakers openly admit their aim to evade the federal SALT terms when they introduce state legislation. But taxation experts note that the IRS has provided positive rulings in more narrow cases about the federal deductibility of state tax credits in 33 states.
For instance, Alabama provides a 100% state tax credit for taxpayers who contribute money that provides children vouchers to attend private school. New York’s new SALT-related provision would give an 85% state tax credit to residents who contribute to a neighborhood charitable fund that supports education. Can one approach be upheld but one other not?