California Advances Bill to Avoid New State Tax Deduction Cap(1)

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By Laura Mahoney

A bill allowing California taxpayers to make charitable contributions to the state to mitigate a new cap on the federal deduction for state-and-local taxes will move on to the Assembly.

Senators approved S.B. 227 by a 27-to-7 vote Jan. 30, with Democrats and two Republicans in favor. Other Republicans either voted no or didn’t cast votes. It must pass the Assembly by Aug. 31 to reach the desk of Gov. Jerry Brown (D). The measure was introduced by Senate President Pro Tempore Kevin De Leon (D).

Several amendments were recently made to the bill, possibly to protect it from administrative or legal challenges. The bill is among a number of controversial approaches California and other high-tax states controlled by Democrats are trying to get around a new limit on the deductibility of state and local taxes on federal income-tax returns, such as replacing income taxes with an employer-based payroll tax system.

At least 3 million Californians who pay more than $10,000 combined in state income and property tax would benefit from the measure, De Leon said.

The bill addresses a provision of the new federal tax law ( Pub. L. No. 115-97), signed by President Donald Trump in Dec. 22 2017, which allows taxpayers to deduct up to $10,000 of property taxes, and state and local income or sales taxes. Previously, the deduction had no limit.

Many high-tax, and traditionally Democratic, states are exploring options to combat the change. Governors from New York, New Jersey and Connecticut plan to sue the federal government over the new tax law, saying it targets Democrats who didn’t vote for President Donald Trump in the 2016 election.

85 Percent Credit

Amendments to SB 227 made Jan. 25 reduce the amount of the state tax credit for charitable contributions to the California Excellence Fund from 100 percent to 85 percent. Taxpayers who use the mechanism would get a state tax credit for 85 percent of their contributions made to satisfy their state income tax liabilities. They could deduct the state credit on their federal income tax returns.

The reduction in the credit amount could address concerns that a 100 percent credit would make it the most generous credit ever allowed, and would run afoul of rules limiting the benefits a taxpayer can receive in exchange for a charitable contribution.

State Deduction, Too

Other amendments to the bill:

  •  allow the credit to reduce regular personal income tax below the tentative minimum tax;
  •  allow contribution amounts to also qualify for a deduction against state income taxes;
  •  allow the Franchise Tax Board to issue regulations to implement the bill outside the usual administrative review process;
  •  eliminate the bill’s application to corporate tax liabilities; and
  •  tie it to passage of a new companion bill that protects school funding from reduced tax revenue that could result.
Republicans who voted against the bill said it would give California taxpayers false hope for relief and wouldn’t withstand Internal Revenue Service scrutiny.

“Taxpayers who embrace this will receive no protection from California when they get an audit letter from the IRS,” Sen. Jeff Stone (R) said. “This is political pandering at its best.”

Even if a state allowed taxes to be characterized as charitable contributions, that wouldn’t make them so for federal tax purposes. IRS Publication 526 says that taxpayers can’t deduct as a charitable contribution any payment for which they receive a benefit in return.

To contact the reporter on this story: Laura Mahoney in Sacramento, Calif., at lmahoney@bloomberglaw.com

To contact the editor responsible for this story: Ryan C. Tuck at rtuck@bloombergtax.com

For More Information

More information about the bill is available at http://src.bna.com/v3d

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