Several high-tax states, including California, New York, New Jersey, and Connecticut, are trying to establish a legislative work-around to the new $10,000 cap on the deduction for state and local taxes (SALT). The cap will only affect the highest-income taxpayers, who have long been the target for state tax increases. Nevertheless, these states apparently fear that the loss of the deduction will increase the competitive disadvantage that results from their tax policies. The work-arounds may involve the creation of quasi-charitable funds controlled by the government and the allowance of a state tax credit for donations to such funds. The theory seems to be that the SALT cap won’t apply to such “donations.” Other schemes involve converting to a payroll tax that would be fully deductible by employers.
The IRS is not likely to agree with any such gimmicks and it signaled disapproval in a notice released in May. New regulations on the subject are coming. Federal law controls the proper characterization of payments and expenses for federal income tax purposes, regardless of what the states may hope. The IRS will use substance over form, which suggests that if a purported charitable gift relieves a taxpayer of a legal obligation to pay a tax, it is not a charitable gift at all.
The affected states appear poised to take the matter to court. Governor Andrew Cuomo of New York said: “New York was the first to take action to protect our residents from this hostile assault and ensure New York families weren’t being used as a piggy bank to pay for tax cuts for big corporations. Now, the administration appears poised to attack again through new tax regulations, showing its true hostility to New Yorkers and middle-class taxpayers.”
On the other hand, the IRS warning may prove so chilling that tax advisors will not recommend any of the work-arounds to their clients.
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