Updated: Jun 29, 2022
Dear Clients & Friends,
As part of the Trump tax legislation of 2018, a $10,000 limit has been placed on the deductibility of state and local taxes (SALT). This effectively makes local taxes more expensive for many taxpayers and negates a great deal of the tax savings this legislation was intended to provide. Therefore, several states have been working on a strategy to circumvent the deduction limit by accepting charitable contributions, which are not subject to the same cap, in lieu of taxes collected. The IRS has released proposed regulations that would shut down some of these suggested workarounds.
Historically, if you itemized deductions on your federal income tax return, you could generally claim a deduction for taxes paid to state and local governments, including income and property taxes (or sales tax in lieu of income tax). For 2018 to 2025, the deduction for state and local taxes is limited to $10,000 ($5,000 for married taxpayers filing separate returns).
Some high-tax states have proposed potential workarounds to the new federal limit on the deduction for state and local taxes, including:
Providing a credit to taxpayers for charitable contributions to a state-created charity in lieu of payment of state income tax (or possibly for the amount of state tax in excess of the $10,000/$5,000 limit); the taxpayer would then claim a federal charitable tax deduction for the payment.
Imposing a tax on employers instead of on employees; it's suggested that the employer could deduct the tax as a business expense on its federal tax return and correspondingly reduce the amount paid to an employee, who effectively receives the same amount on an after-tax basis.
The proposed regulations address only the concept of trying to reposition payment of state taxes as charitable contributions.
The proposed IRS regulations would restrict the charitable deduction workaround by:
Reducing the federal charitable deduction for individuals to the extent that a state provides a state or local tax credit in return for a payment or transfer of property to charity. However, the federal deduction for charitable contributions would not be reduced if the state or local tax credit does not exceed 15%.
Reducing the federal charitable deduction for individuals if a tax deduction is provided at the state or local level in return for a payment or transfer of property to charity, in cases where that deduction is greater than the amount of the payment (or the fair market value of donated property).
The proposed regulations have an effective date for amounts paid and property transferred after August 27, 2018.
An individual makes a payment of $1,000 to a charity. In exchange for the payment, the individual is entitled to a state tax credit of 70% of the payment. The federal charitable deduction is reduced by $700 ($1,000 x 70%) to $300.
An individual contributes a painting worth $100,000 to a charity. In exchange for the contribution, the individual is entitled to a state tax credit of 15% of the fair market value of the property. The federal charitable deduction is not reduced because the credit does not exceed 15%.
An individual makes a payment of $1,000 to a charity. In exchange for the payment, the individual is entitled to a state tax deduction equal to the amount of the payment. The federal charitable deduction is not reduced because the deduction does not exceed the amount of the payment.
Keep in mind that whether or not these limits based on state or local tax credits or deductions apply, the amount of your charitable deduction may be limited to certain percentages of your adjusted gross income, depending on the type of charity and the property contributed.
We know that many of our clients have been severely stricken by this SALT tax deduction limit and we’ll do our best to keep everyone posted.
Have a lovely weekend.
*Research provided by Broadridge Research Solutions.
Matthew Ramer, AIF® Principal, Financial Advisor MOR Wealth Management, LLC
1801 Market Street, Suite 2435 Philadelphia, PA 19103 P: 267.930-8301 | c: 215-694-4784 | f: 267.284.4847 |
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MOR Wealth Management does not provide legal or tax advice. You should consult a legal or tax professional regarding your individual situation.