For over 50 years, Bloomberg Tax’s renowned flagship daily news service, Daily Tax Report® has helped leading practitioners and policymakers stay on the cutting edge of taxation and...
Treasury Secretary Steven Mnuchin threatened to target tax audits at residents of states such as California and New York that are seeking ways to restructure their state income taxes to lessen the blow of the new tax law.
High-tax states have been looking for ways to creatively get around the tax law that caps at $10,000 the amount of state and local taxes their residents can deduct. California has proposed to allow residents to make a donation to the state to satisfy their income tax liabilities and claim the charitable contribution as a credit to reduce their federal tax bill. New York is considering swapping the personal income tax for a business payroll tax that employers could deduct.
“I can assure you we will audit the real estate taxes issue,” Mnuchin said Jan. 12 at the Economic Club of Washington, responding to a question about states’ plans to create workarounds.
The comment highlights what is one of the most politically sensitive points in the tax overhaul—Democrats say the GOP targeted blue states, which tend to have higher taxes, to fund their tax overhaul. Republicans argue that the deduction subsidizes high-tax state residents.
The Internal Revenue Service and Treasury Department didn’t respond to a request for comment on how the audits would work and what authority the agency has to disallow deductions.
Mnuchin’s comments furthered the debate that has been playing out between the Republican-led Congress and Democratic governors and state legislatures since the new tax act ( Pub. L. No. 115-97) passed Dec. 22, with each side trying to outsmart the other to get the final word.
“People are angry about what they interpret as Republicans in Congress using the tax law to hammer their political opponents,” said Daniel Hemel, an assistant professor of law at the University of Chicago. “If you’re a blue state, this is political gravy. You are saving money for residents and protecting the state’s ability to collect revenue. Why wouldn’t you do this?”
States might not do this if they’re not sure it will hold up to IRS scrutiny, said Jared Walczak, a senior policy analyst at the Tax Foundation.
“The IRS operates on the concept of substance over form,” he told Bloomberg Tax. “What a state or local government calls it or how they frame it matter much less that what it actually is.”
Walczak says existing IRS guidance, regulations, and case law make it unlikely that the California charitable contribution plan will work out. The New York plan is tougher to challenge legally, he said, but does present logistical difficulties in implementing the system.
But for states where significant revenue is at stake—which could be tens of billions dollars for residents in California or New York—the cost may be worth the potential savings, Hemel said.
“Maybe the IRS drags people through audit, but it’s still a heads we win, tails we tie situation,” he said. “If IRS shuts this down, people wouldn’t be worse off than they are now.”
Mnuchin’s warning of audits raises a practical consideration, said Donald Williamson, the executive director of American University’s Kogod Tax Center. The IRS doesn’t have the manpower to audit every New York and California taxpayer, he said.
The number of audits the IRS conducts annually has been steadily decreasing, falling nearly 34 percent from 2009 to 2015 as the agency’s budget has declined, according to IRS data. Additionally, audits take several years to select and complete, so it’s unclear how many auditors the agency will have in the future.
“Right now they’re auditing 2015 and won’t be done for a couple months,” Williamson said. “2018 audits won’t occur until 2020 or 2021. That’s a long way out.”
To contact the reporter on this story: Laura Davison in Washington at firstname.lastname@example.org
To contact the editor responsible for this story: Meg Shreve at email@example.com
Copyright © 2018 The Bureau of National Affairs, Inc. All Rights Reserved.
All Bloomberg BNA treatises are available on standing order, which ensures you will always receive the most current edition of the book or supplement of the title you have ordered from Bloomberg BNA’s book division. As soon as a new supplement or edition is published (usually annually) for a title you’ve previously purchased and requested to be placed on standing order, we’ll ship it to you to review for 30 days without any obligation. During this period, you can either (a) honor the invoice and receive a 5% discount (in addition to any other discounts you may qualify for) off the then-current price of the update, plus shipping and handling or (b) return the book(s), in which case, your invoice will be cancelled upon receipt of the book(s). Call us for a prepaid UPS label for your return. It’s as simple and easy as that. Most importantly, standing orders mean you will never have to worry about the timeliness of the information you’re relying on. And, you may discontinue standing orders at any time by contacting us at 1.800.960.1220 or by sending an email to firstname.lastname@example.org.
Put me on standing order at a 5% discount off list price of all future updates, in addition to any other discounts I may quality for. (Returnable within 30 days.)
Notify me when updates are available (No standing order will be created).
This Bloomberg BNA report is available on standing order, which ensures you will all receive the latest edition. This report is updated annually and we will send you the latest edition once it has been published. By signing up for standing order you will never have to worry about the timeliness of the information you need. And, you may discontinue standing orders at any time by contacting us at 1.800.372.1033, option 5, or by sending us an email to email@example.com.
Put me on standing order
Notify me when new releases are available (no standing order will be created)