Posted by Evan Piccirillo, CPA
The recently enacted Tax Cuts and Jobs Act (TCJA) makes some potentially detrimental changes to state and local tax (SaLT) deductions, namely a limitation on the tax deduction of $10k for married filers and $5k for single filers for state taxes. Prior to the TCJA, there was no such limitation (even though some taxpayers were hit with the Alternative Minimum Tax, but that is a different discussion). This presents a problem for taxpayers in “high-tax” states: any jurisdiction that imposes a high income tax, a high property tax, or both, such as New York, New Jersey, California, and Connecticut. The TCJA did not cap the deduction on charitable contributions; in fact, they increased the limit from 50% to 60% of adjusted gross income for certain types of gifts, and even then excess contributions are allowed to be carried over into subsequent years.
If only there was some way to decrease the amount of state taxes paid to say, less than $10K, while at the same time increasing charitable gifts! State legislators in these high-tax states were quick to cook up a work-around to this change and came up with a doozy. States will establish state-run charitable trust funds. Taxpayers would be allowed a state tax credit of some percent (New York provides 85%; New Jersey, 90%) of their contribution to these funds, and in theory, also get a deduction on their federal tax return for a charitable contribution. Thus, states would shift the character of payment from one category to the other and there will be much rejoicing (and tax deductions).
The IRS wasted little time responding and announced that they will release proposed regulations to provide guidance to taxpayers on how the IRS is the authority on the characterization of charitable contribution and it doesn’t matter what the states say. The central factors in determining if a charitable contribution is deductible is that it 1) is paid to a qualified organization (which the states’ trust funds can meet) and 2) the deduction must be reduced by any benefit the taxpayer receives. If you have been paying attention, you will have noticed that, in this arrangement, the taxpayer would receive a benefit for their contribution in the form of a tax credit, and therefore they would have to reduce their charitable contribution deduction by the state tax credit they received. This results in a net zero benefit to taxpayers.
More than anything, this is posturing by politicians in state and federal positions. Unfortunately for those of us in high-tax states, we will have to deal with paying taxes to our state and not getting the benefit we were used to getting in the past. There are other important issues that states will have to address in the wake of the TCJA which we will discuss in future posts. If you would like to complain about this or other topics, reach out to your trusted advisor, or give me a call.