IRS Shuts Door on SALT Creative Workarounds
The IRS said no to some of the creative workarounds for the new $10,000 limit on the deductibility of state and local taxes (SALT). Its new guidance appears to close the door on a strategy offered by the state of New York and some other states to circumvent the deduction limit by attempting to turn the taxes paid into charitable contributions not subject to the same cap.
Before Tax Reform
Historically, if you itemized deductions on your federal income tax return, you could claim a deduction for taxes paid to state and local governments, including income and property taxes (or sales tax in lieu of income tax). However, for 2018 to 2025, the deduction for state and local taxes is limited to $10,000 annually ($5,000 for married taxpayers filing separate returns).
New York and other high-tax states have proposed potential workarounds to the new federal limit on the deduction for state and local taxes, including:
- Providing a credit to taxpayers for charitable contributions to a state-created charity in lieu of payment of state income tax (or possibly for the amount of state tax in excess of the $10,000/$5,000 limit); the taxpayer would then claim a federal charitable tax deduction for the payment.
- Imposing a tax on employers instead of on employees; it’s suggested that the employer could deduct the tax as a business expense on its federal tax return and correspondingly reduce the amount paid to an employee, who effectively receives the same amount on an after-tax basis.
The proposed regulations address only the concept of trying to reposition payment of state taxes as charitable contributions.
The proposed IRS regulations would restrict the charitable deduction workaround by:
- Reducing the federal charitable deduction for individuals to the extent that a state provides a state or local tax credit in return for a payment or transfer of property to charity. However, the federal deduction for charitable contributions would not be reduced if the state or local tax credit does not exceed 15%.
- Reducing the federal charitable deduction for individuals if a tax deduction is provided at the state or local level in return for a payment or transfer of property to charity, in cases where that deduction is greater than the amount of the payment (or the fair market value of donated property).
- The proposed regulations have an effective date for amounts paid and property transferred after August 27, 2018.