The IRS has released proposed treasury regulations that would limit several states’ efforts to circumvent the new $10,000 federal SALT deduction cap. Under the regulations, the IRS will deny charitable deductions to the extent that a state or local tax credit is granted for the corresponding contribution. However, this limitation will not apply if the state or local tax credit equals 15 percent or less of the amount contributed. Below is a look at how these rules would affect states’ SALT cap deduction workarounds.
Arkansas’ Tax Reform and Relief Legislative Task Force has approved a proposed elective pass-through entity tax that could be used to avoid the SALT deduction cap imposed on individuals. According to the Task Force, the optional new tax “would allow a pass-through entity to elect to pay Arkansas income tax directly to [the state] in the same manner as a C corporation, which would allow a pass-through entity to take a SALT deduction under federal law in the same manner as a C corporation.” This would be unaffected by the proposed treasury regulations.
Earlier this year, the California Senate passed a bill under which the state would grant taxpayers a credit against their individual income tax liability equal to 85 percent of the amount they contribute to the newly created Local Schools and Colleges Voluntary Contribution Fund.
As originally introduced, the bill provided a 100-percent credit for contributions to the fund. The bill has since stalled in the Assembly. As Bloomberg Tax’s Laura Mahoney recently reported (subscription required), the bill’s chief sponsor, Sen. Kevin de León (D), is now backing a newer bill which would increase an existing 50-percent income tax credit for contributions to a state scholarship program to 75 percent.
The federal tax deduction available for such contributions will be limited under the proposed regulations. For instance, a taxpayer who under the existing program claims a $10,000 credit for a $20,000 contribution would have the federal charitable deduction limited to $10,000 (the excess of the contribution over the credit). If the credit amount is increased to 75 percent, the state credit would be $15,000 and the federal deduction would be $5,000. In all cases, taxpayers would end up paying less by simply claiming the SALT deduction, even with its $10,000 cap.
In May, Connecticut enacted a new pass-through entity tax at the rate of 6.99 percent. The tax is to be fully offset by individual income tax credits to an entity’s owners. This appears to be the model for the optional new pass-through entity tax being considered by Arkansas and is likewise unaffected by the proposed treasury regulations. In the same bill, Connecticut also authorizes municipalities to create charitable organizations that support town services and provide property tax credits for taxpayers making voluntary contributions to such organizations. The proposed treasury regulations would limit the tax benefit of this workaround.
An Illinois bill that would create the Illinois Education Excellence Fund and permit an income tax credit equal to 100 percent of the amount contributed to the fund has passed the House and Senate. However, the bill has since been held up in the House; the new treasury proposals may be its death knell.
In May, New Jersey passed legislation authorizing local taxing jurisdictions to create charitable funds and grant property tax credits equal to 90 percent of voluntary contributions to such funds. The proposed treasury regulations could prompt the Garden State to seek greener pastures.
In April, the Empire State enacted its Omnibus Budget Bill. The bill enacted the following SALT deduction cap workarounds that will be limited by the proposed regulations: (1) state income tax credits for voluntary contributions to the state’s newly-created Charitable Contribution Fund; and (2) real property tax credits for contributions to local charitable gift reserve funds. The bill also creates an elective payroll tax, which will be unaffected by the regulations.
What are the states’ odds of successfully challenging the proposed regulations? Continue the discussion on Bloomberg Tax’s State Tax Group on LinkedIn.
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