SALT Workarounds Nixed by Proposed Regulations

After the Tax Cuts and Jobs Act of 2017 put a $10,000 cap on the itemized deduction (starting in 2018) for state and local taxes ($5,000 for married persons filing separately), some states created or are considering the creation of workarounds to help their high-tax residents continue to claim federal tax breaks. One such workaround is allowing residents to get state tax credits for making certain payments to a charitable fund for public services, such as amounts covering property taxes. The IRS has issued proposed regulations clarifying the federal income tax treatment of these state workarounds (IR-2018-172).

Under the proposed regulations, an individual who makes payments or transfers property to an entity eligible to receive tax deductible contributions must reduce their federal charitable deduction by the amount of any state or local tax credit the taxpayer receives or expects to receive in return (i.e., the quid pro quo).

For example, if individual pays $1,000 to an eligible entity (e.g., a government entity to which tax-deductible contributions can be made) and the state grants a 70% state tax credit, the person receives a $700 state tax credit. The otherwise allowable federal charitable contribution deduction of $1,000 is reduced by the $700 state tax credit, leaving an allowable contribution deduction of $300 on the person’s federal income tax return.

There is an exception for dollar-for-dollar state tax deductions and for tax credits of no more than 15% of the payment amount or of the fair market value of the property transferred. So an individual who makes a $1,000 contribution to an eligible entity is not required to reduce the $1,000 deduction on his or her federal income tax return if the state or local tax credit received or expected to be received is no more than $150.

Note: The IRS has asked for comments on these proposed regulations, so this may not be the final word on the matter. Look for future developments on this matter.