Attempts to Circumvent $10,000 SALT Cap Blocked
The U.S. Treasury Department recently issued a new regulation stating that taxpayers cannot claim that they made a charitable contribution if they received a state tax credit in exchange for a “gift” to a state fund. This rule effectively blocks state proposals aimed at circumventing the federal SALT cap.
We recently wrote about California’s attempt at workarounds to the Tax Cuts and Jobs Act’s $10,000 cap on federal deductions for state and local taxes (SALT). These proposals aimed at circumventing the SALT cap by utilizing the charitable deduction, which has no limit. One proposal involved state tax credits for taxpayers who donate to the California Excellence Fund, another to those who purchase Golden State Credits that support California educational institutions.
We also explained that it was unlikely that the government would permit this.
The proposed regulations
The U.S. Treasury Department recently issued a proposed new regulation on this matter that takes effect on August 27, 2018. As predicted, the regulation states that the amount of a taxpayer’s charitable deduction under 26 U.S. Code Section 170 will be reduced by any SALT credit received or expected to be received by their home state.
The proposed regulation clarifies that taxpayers cannot claim that they made a charitable contribution if they received a substantial benefit in exchange for their gift. Only amounts that don’t produce a return benefit will be deductible as a charitable contribution (e.g., amounts that exceed the fair market value of the benefits received).
For example, if a California taxpayer were to make a $10,000 contribution to the California Excellence Fund and receive an 85% ($8,500) state tax credit, only the difference ($1,500) would be allowed as a deductible charitable contribution for federal tax purposes. The reason for this is that the taxpayer has received a benefit for their gift – an $8,500 tax credit. Note that the rule also applies to payments made by estates and trusts.
There is an exception – if the SALT credit received or expected to be received is less than 15% of the amount “donated”, the full amount may be taken as a charitable deduction.
A number of states with high state and local tax rates have proposed other measures to circumvent the SALT deduction cap – through 2025, New York residents will lose over $135 billion on their federal taxes as a result of the new tax law.
New York has also filed suit against the federal government, joined by Connecticut, Maryland and New Jersey. The lawsuit claims that the new federal tax law targets and harms high-tax states and their residents, and interferes with state’s rights to make their own fiscal decisions.
California tax attorneys
In California, the average itemized SALT deduction before the Tax Cuts and Jobs Act came into effect was around $18,000 – nearly double the new SALT cap. The cap could therefore have a significant effect on your new tax return and it is now more important than ever to ensure that your financial and business affairs are structured to your maximum advantage. The tax attorneys and accountants at Moskowitz, LLP can help. Call our San Francisco offices today.