State Plans to Mitigate Federal Tax Cap No Sure Thing

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 David McAfee

States looking for end-runs of the new federal tax law may not face an easy path.

States are primarily looking to reclassify certain payments as charitable contributions or create employer-based payroll taxes, but both methods come with their own problems, according to Adam Thimmesch, a professor at the Nebraska College of Law.

“In one fashion or another, what states are grappling with and trying to figure out is how to characterize or reclassify those payments,” Thimmesch said Feb. 9 during a panel discussion at the American Bar Association Section of Taxation’s Midyear Meeting in San Diego, Calif. “I don’t know that I can provide any great advice on whether it works or not.”

He pointed to California S.B. 227, which would allow taxpayers to contribute to the California Excellence Fund and receive a tax credit as a result. Several other states, including New Jersey, New York, and Connecticut, are also considering an option to reclassify taxes as charitable contributions as a way to mitigate increased state and local tax burdens under the 2017 federal tax act ( Pub. L. No. 115-97). Under the new law, taxpayers who itemize deductions on their federal return may deduct up to $10,000 in state sales, individual income, and property taxes. Previously the deduction was unlimited.

But the Internal Revenue Service may attempt to scotch the idea. Treasury Secretary Steven Mnuchin, during a Jan. 12 talk in Washington, threatened to target tax audits at residents of states that allow deductions for charitable donations to state charities that provide funding for public services. IRS Publication 526 says that taxpayers can’t deduct as a charitable contribution any payment for which they receive a benefit in return.

‘Windfall’ for States

While states are looking at ways to reduce the burden the new tax law places on some of their residents, some are being quiet about the “windfall” that the new federal law means for them.

Because the new law broadens the base of what’s subject to taxation, states that conform to the federal Internal Revenue Code would see increased revenue without having to raise rates, according to Nikki E. Dobay, senior tax counsel at the Council On State Taxation.

States “are not highlighting this issue,” she said during the panel.

To contact the reporter on this story: David McAfee in San Diego at dmcAfee@bloomberglaw.com

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

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