California’s Attempts to Circumvent the New Tax Law’s SALT Limitation

Reports indicate that low-income and middle-class Californians are fleeing the state – most are relocating to Arizona, Nevada, and Texas. The reason? Housing costs and high taxes.

The new tax law hasn’t necessarily helped wealthy California homeowners, either. For one thing, the Tax Cuts and Jobs Act (TCJA) capped their federal deduction for state and local taxes (SALT) at $10,000. Since then, high-tax states have been exploring ways to make up for the difference.

The California Excellence Fund

Senator Kevin De León’s “California Excellence Fund” (S.B. 227) would allow taxpayers to make voluntary charitable contributions to a new state-sponsored charity and receive a state tax credit of 85 percent as a credit against their state tax liability. The California State Senate approved this legislation this past January. The goal is to enable California taxpayers who itemize their deductions to claim their state tax payment as a charitable contribution (which is fully deductible under federal tax law) rather than as a state tax deduction – thereby circumventing the SALT limitation.

The Golden State Credits Plan

A similar proposal by Assembly Revenue and Taxation Committee Chair Autumn Burke (A.B. 2217) would sell “Golden State Credits” to taxpayers for $1 each in exchange for a state tax credit of 80 percent of their purchase amount. California nonprofit organizations with 501(c)(3) tax-exempt status, K-12 public schools, California community colleges, and colleges and universities who receive state grants could purchase these credits from the California Treasury for 90 cents each.

Supporters and critics

Critics note that taxpayers are unlikely to gain from these schemes since the IRS will not allow taxpayers to write off a “charitable gift” that brings them substantial benefit. See IRS Publication 526. From the beginning, they have argued that the IRS is unlikely to permit any such workarounds – under federal tax law, charitable contributions must have a genuine charitable intent and purpose, and an actual benefit to the recipient of the funds. For the most part, they argue, these plans simply recharacterize tax payments without increasing the state coffers.

Supporters of these plans claim that there are numerous programs nationwide in which taxpayers receive tax credits for donations they make to state funds (e.g., private school vouchers). They say that it will be difficult for the federal government to maintain that California should not be able to offer credits for state and local taxes while these other programs remain in effect.

The IRS Response

On May 23, 2018 the IRS issued Notice 2018-54, informing taxpayers that the Treasury Department and the IRS are in the process of drafting regulations that will clarify “the relationship between the federal charitable contribution deduction and the new statutory limitation on the deduction for state and local tax payments.” The notice explicitly states that the Internal Revenue Code, “informed by substance-over-form principles,” governs the federal income tax treatment of payments made in exchange for a credit against state and local taxes – a hint that critics of these plans have correctly predicted the IRS’ response.

California tax planning services

The tax attorneys and accountants at Moskowitz, LLP assist many California taxpayers with numerous SALT issues, and can help you legally minimize your federal income tax liability. Contact our San Francisco offices today.

Related Post: Salt Deductions under the New Tax Law

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