Connecticut Becomes Third State to Pass Tax Workaround Law

Daily Tax Report: State provides authoritative coverage of state and local tax developments across the 50 U.S. states and the District of Columbia, tracking legislative and regulatory updates,...

By Aaron Nicodemus

Connecticut has joined New York and New Jersey in enacting a law giving taxpayers the ability to work around the state and local tax deduction cap contained in the new federal tax law.

Gov. Dannel Malloy (D) signed the law (Public Act No. 18-49) May 31. The law contains two separate options to help the state’s taxpayers offset the impact of the $10,000 SALT deduction cap contained in the 2017 federal tax act ( Pub. L. No. 115-97).

The bill creates a new “revenue-neutral” state tax on pass-through entities, which is offset by a corresponding personal income tax credit. The amount of the new state tax is a deductible expense on a business’s federal income tax return, according to the Department of Revenue Services. The measure is meant to reduce the federal tax obligations of small business owners.

The new law also allows Connecticut municipalities to create charitable organizations that support town services, in conjunction with a local property tax credit. Taxpayers making a contribution to the new organizations will receive a corresponding credit on their local property taxes.

The charitable contribution workaround might fail to pass muster with the Internal Revenue Service, which warned taxpayers in workaround states such as New York and New Jersey to proceed with caution when making donations to state-sponsored charitable funds designed to circumvent the $10,000 cap. The service said it intends to propose regulations addressing the deductibility of state and local tax payments for federal income tax purposes.

Taxpayers should be aware “that federal law controls the proper characterization of payments for federal income tax purposes,” the IRS said in a May 23 notice.

Lawmakers in Illinois and California are considering similar tax workaround plans.

To contact the reporter on this story: Aaron Nicodemus in Boston at anicodemus@bloomberglaw.com

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

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