Will the IRS Stop States From Avoiding Tax Deduction Caps?

By far, one of the most controversial aspects of the new Tax Cut and Jobs Act (TCJA) has been the reduction in the state and local income tax deduction. This has long been an important deduction for many people. Beingable to deduct your state and local taxes (SALT) from your federal return has been a big boost for taxpayers all over the country. That’s especially true for taxpayers that live in states with high income tax, like New York, New Jersey and California.

Deduction Cap Hurts Taxpayers in High-Tax States
The TCJA allows a deduction of up to $10,000 combined for either income tax or sales tax and property tax. But for people living in the highest tax states that is little consolation, as $10,000 won’t go very far. Recently, several high-tax states have taken the matter into their own hands by introducing and passing legislation that allows taxpayers to work around this problem.

Workarounds Could Save Thousands
Here’s how they work. Municipalities will be allowed to create charitable funds to help pay for local services. They will also offer property tax credits to give homeowners extra incentive to make contributions. Those who itemize their deductions would be able to claim a charitable deduction on their federal taxes, for more than the $10,000 SALT cap.

The workarounds could save many taxpayers thousand of dollars. For example, the average SALT deduction for New York residents was $22,169 in 2015. That’s a loss of more than $12,000 on average under the new law. The numbers are similar for residents of Connecticut and New Jersey.

The Government May Still Fight Back
That’s why many taxpayers were thrilled to hear of these legislative acts to help offset the loss of this deduction. However, the story doesn’t end there. In fact, it might just be getting started. That’s because theIRS may decide to fight back. Therefore, according to many accountants, taxpayers should be careful.

So far, U.S. Treasury Secretary, Steve Mnuchin has said: “I hope that the states are more focused on cutting their budgets and giving tax cuts to their people in their states than they are in trying to evade the law.”

States Prepared to Fight
The states that have passed legislation havealready stated they are willing to go to court to fight for their legislation workarounds. However, many accountants and tax advisors are telling taxpayers to hold off on making these charitable contributions for now. It is likely that the federal government and the IRS will contest what these states are doing and fight them in court.

Play it Safe for Now

Some attorneys, as well as critics of the workarounds, have noted that in order for a contribution to be deductible, the IRS requires a charitable intent to be present. Additionally, they say the fact that municipalities are offering donors a credit for donating to a charitable fund might look a little fishy. So far, for its part,the IRS has not said one way or the otherwhether or not it will allow the workarounds to go forward. However, for now, it might be in the best interest of taxpayersin these states, to wait to find out.