New York’s Federal Tax Deduction Workaround Pays Off, May Not Last

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 Gerald B. Silverman

A New York tax credit designed to blunt the hit taxpayers took from the federal tax law’s new cap on state and local deductions was just picking up steam when the Internal Revenue Service dealt it a blow.

The program, which allows taxpayers to receive a tax credit for a charitable gift to the state, brought in $57.2 million in contributions in September and $35.3 million in August, for an average of $46.2 million per month, according to a Bloomberg Tax analysis of data from the state comptroller.

If the program continued at that pace, the state would collect a total of $554 million over 12 months.

New York knew it was stepping into uncharted waters when it enacted the gift workaround, but now it knows the impact of IRS regulations that essentially barred taxpayers from getting the federal deduction.

New York was the first state out of the box with the charitable gift workaround to the federal tax law’s (Pub. L. No. 115-97) $10,000 cap on the state and local tax deduction, although other high-tax states have followed suit. The goal of the state credits is to mitigate the impact of the SALT deduction cap by giving taxpayers the option to make a charitable gift to the state and then get a state credit and a federal deduction against their personal income.

The IRS, however, shot down the plans in August when it proposed regulationsrequiring donors who receive a state or local tax credit to reduce any federal deduction for that contribution by the amount of the state tax credit.

“The fact that the charitable gifts trust fund has collected nearly $100 million underscores the severity of the federal tax law’s impact on New Yorkers,” Morris Peters, a spokesman for the state Division of the Budget, told Bloomberg Tax in an email.

“The elimination of full state and local tax deductibility will cost New York families at least $14.3 billion each year, effectively raising our taxes relative to other states,” he said. “We will continue to use every tool at our disposal, including litigation, to fight back and ensure New Yorkers aren’t being used as a piggy bank.”

Expected Collections

The state didn’t include estimates for the charitable gift program in the 2018-19 budget, recognizing the uncertainties of taxpayer behavior and the IRS response. Still, the maximum amount the state could collect was estimated at $28 billion, if every eligible taxpayer contributed at a level equal to their SALT payments, minus the new $10,000 SALT cap, according to a quarterly update released by the Budget Division in August.

The August report described the $28 billion figure as “a stress test” that “should not, under any circumstances, be viewed either as an estimate or projection of likely donations.”

The New York law created two charitable funds—one for education and one for health care. It also allowed local governments to create charitable funds to mitigate the impact of the SALT cap on taxpayers with high property taxes.

Mark E. Johnson, a spokesman for state Comptroller Thomas P. DiNapoli (D), said there was $57.3 million in the health care fund, as of Sept. 30, and $35.2 million in the education account.

“That number is higher than I would have expected, in light of the IRS position as expressed in the proposed regulations,” Peter L. Faber, a partner at McDermott, Will & Emery, told Bloomberg Tax in an email. “People may be playing the audit lottery, betting that they won’t be audited.”

E.J. McMahon, research director at the Empire Center for Public Policy, a conservative-leaning think tank, told Bloomberg Tax that the amount collected was more like “a rounding error” than a significant sum.

“The state had no expectations,” although Gov. Andrew M. Cuomo’s (D) general rhetoric would suggest “he wants this viewed as a game-changer,” McMahon said.

Darien Shanske, a law professor at the University of California, Davis, School of Law, said the amount collected was “robust,” given all the legal uncertainty created by the IRS.

“No one expected these workarounds to mitigate the costs completely,” said Shanske, who is one of the leading proponents of the charitable gift workarounds. “It seems unlikely there will be a great deal of use of the NY program until there is more legal certainty.”

Odds May Change

New York, New Jersey, Connecticut, and California are asking the IRS to withdraw the proposed regulations. In addition, New York, New Jersey, Connecticut, and Maryland have sued to overturn the 2017 federal tax law.

“I suspect that the IRS will have a special project to audit this issue,” Richard D. Pomp, the Alva P. Loiselle Professor of Law at the University of Connecticut School of Law, told Bloomberg Tax in an email.

“If so, the odds will have changed against playing this game—and not in favor of the taxpayer,” he said.

Lucy Dadayan, a senior research associate at the Urban-Brookings Tax Policy Center, said “the political fight over the SALT deduction is far from being over.”

“We will continue witnessing a wave of political upheaval in the coming months as the blue states will continue the battle over SALT deduction limit,” she told Bloomberg Tax in an email.

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