Tax Reform Friday: IRS Warns Taxpayers About Employing State Deduction Workarounds, New Jersey Responds

On May 23, the IRS issued a notice indicating that taxpayers should be cautious in attempting to employ state tax workarounds to lower their federal income tax liabilities. Because federal tax law now caps the deduction for state and local taxes at $10,000, taxpayers in high-tax states stand to pay increased federal taxes. Legislatures in states like New Jersey, New York, and Connecticut are allowing their taxpayers to allocate state tax liability as a charitable contribution to the state in the hope that this format will qualify the payments for charitable deduction under federal law.

In IRS Notice 2018-54, the IRS indicated that it will not look favorably on state attempts to get around the $10,000 deduction limit. Citing the substance-over-form doctrine, the notice states that the treasury department and IRS intend to propose regulations that will not allow deducting state tax payments that states characterize as charitable contributions. Additionally, taxpayers are reminded that states don’t have the final word in whether these state workarounds will pass muster under federal law; instead “federal law controls the proper characterization of payments for federal income tax purposes.”

It appears that at least some of the affected states do not view the IRS’s plans favorably; New Jersey Attorney General Gurbir Grewal responded to the IRS’s notice by saying that the state would “challenge the new rule in court” if these plans come to fruition, as reported by the Daily Tax Report (subscription required).

Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn: Do you predict state workarounds will ultimately prove successful?

For more information on the impact of Pub. L. No. 115-97, examine Bloomberg Tax’s Tax Reform Roadmap, showing detailed comparisons between pre-reform law and impending changes, with pertinent cites attached.

Tune in for Bloomberg’s tax reform webinar on Wednesday, May 30, 2018, from 2 pm to 3 pm. “Federal Tax Reform: State Impact and Responses” will give you a snapshot of state responses to federal tax reform and let you know what to expect during the remainder of the year. Register for this webinar here.

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