State Attempts to Circumvent SALT Deduction Limit Won’t Work

What is the SALT deduction limit?

One of the provisions of the Tax Cuts and Jobs Act that was passed in December of 2017 limits the itemized deduction for state and local taxes (SALT) to $10,000.  This limit applies to state income tax, local income tax, real estate taxes, and personal property taxes combined.  In states with high real estate taxes, this new provision will significantly limit a taxpayer’s itemized deductions.

How did states plan to circumvent the SALT limit?

Some states, including New Jersey, tried to get around this problem by passing new state laws that allow residents to make a charitable donation to a state “charity” in exchange for a credit on their real estate taxes.  Since there is no cap on the deduction for charitable contributions, the taxpayer would be able to deduct the full amount of the payment to the state charity.

What did the IRS say?

In proposed regulations issued by the IRS on August 24, 2018, it becomes clear that this scheme won’t work.  One of the requirements for a charitable contribution deduction is that the donor must not receive any “return benefit” from the donation.  For example, if someone pays $100 to attend a charity event, but the cost of the dinner served to him is $30, then he can only deduct the remaining $70 as a charitable contribution.  Since receiving a credit against real estate tax is a quid pro quo benefit of donating to these newly created state charities, the donation is not deductible.

The regulations state that an individual, estate, or trust must reduce the amount of any charitable contribution by the amount of any SALT credit received or expected to be received as a result of the payment.  This means that only the portion of the deduction in excess of the tax credit is deductible.

There is a de minimis exception if the benefit received is 15% of the payment or less.  This means that a taxpayer contributing $10,000 to a charity could still deduct the full amount as long as the real estate tax credit he receives is no more than $1,500.  Most states were going to offer far more than 15% credit, however.  New Jersey would have allowed a real estate tax credit equal to 90% of the charitable contribution.  Other states with high real estate taxes like California, Connecticut, and New York also had similar plans to get around the SALT deduction limit.

When do the new regulations start?

If the proposed regulations become final as they are written, they will apply to any contribution made after August 27, 2018.  It is unlikely, however, that the IRS would allow full charitable deductions even for contributions made prior to this date.  The rule about quid pro quo benefits is not a new rule and there is plenty of case law regarding this issue.

Contact an Alloy Silverstein CPA for specific guidance to your individual situation.