Late last year the Tax Cuts and Jobs Act (TCJA) was passed marking the first time in almost 30 years that our country has seen such a massive overhaul of our tax laws. While tax rates across the board were cut, those reductions had to be paid for, and thus, there were some winners and some losers.
One of the most controversial provisions of the new law was the limitation placed on the deduction for state and local taxes (SALT) for tax years beginning in 2018 through 2025. Prior to TCJA, individual taxpayers were able to deduct, without limitation, 100% of their state income taxes and state real estate taxes, collectively SALT. Under the new rules provided by TCJA, individual taxpayers can still deduct their SALT, however, TCJA places a cap of $10,000 on the deduction. This means that individuals are limited to a maximum $10,000 deduction for their combined state income and state real estate taxes. Taxpayers in states with high income and real estate taxes, like New Jersey and New York, are concerned that this provision will be very costly for them.
In an effort to circumvent this cap, both the New Jersey and New York Legislatures have passed bills that would allow local governments to accept real estate tax payments from its residents in the form of charitable contributions. The legislation in both states authorized municipalities across the state to create charitable funds that would accept such “contributions”. Residents who contribute to these funds would receive tax credits against their real estate tax bills. The significance of this workaround is that property tax payments, the deductibility of which is limited under TCJA, are essentially converted to charitable contributions and, under TCJA, the deduction for charitable contributions has been favorably modified.
In addition to the charitable contribution workaround discussed above, the legislators in New York have proposed a second potential solution to the cap. The other workaround comes in the form of an employer-side payroll tax with an offsetting income tax credit on the employee side. While the New York payroll tax legislation may pass muster from a legal standpoint, this provision will likely only benefit a small segment of taxpayers.
While the charitable contribution legislation appears to be a solution for taxpayers in high-income tax and high property tax states the IRS recently responded to this, and other state’s similar legislation, by issuing Proposed Regulations that address the availability of charitable contribution deductions where a taxpayer receives or expects to receive, a tax credit against their property taxes.
The Proposed Regulations state that a taxpayer making a charitable contribution to a municipality’s established charitable fund must reduce the amount of their otherwise deductible charitable contribution by the amount of any state tax credit they receive, or expect to receive. The reason for this reduction is that in order for a charitable contribution to be fully deductible, the contributor cannot receive anything in return (i.e., the quid pro quo of a tax credit).
There is an exception, however, under the Proposed Regulations for tax credits that do not exceed 15% of the amount of the charitable contribution. In such case, the taxpayer would not have to reduce the amount of the charitable contribution for the tax credit received. As an example, if a taxpayer makes a $1,000 charitable contribution and receives a tax credit of $150 or less, then they can claim the full $1,000 charitable contribution.
While these Proposed Regulations are currently not binding, it is likely that after the public comment period they will be finalized and applicable to all taxpayers. In the meantime, now is the time to start the year-end tax planning process. You are strongly encouraged to discuss this and other changes impacting your 2018 tax liability with your tax adviser.