Each year, thousands of CPAs and financial planners—like us—use their creativity and ingenuity to try to determine the best (legal) ways to lower your federal taxes. You know you’re living in interesting times when state lawmakers join that crowd!
The reason state legislators are working so hard to lower your federal taxes is something popularly known as the SALT (“state and local taxes”) provision of the new Tax Cuts + Jobs Act, which set a $10,000 limit on the deductibility of state and local taxes. That limit does not worry residents of Texas, Florida, or other no/low income-tax states. However, people living in high income-tax states like New York and California generally pay far more than $10,000 to the state alone, on top of the property and municipal taxes they are assessed.
Those higher-tax states are now using that aforementioned creativity and ingenuity to help their citizens get back those deductions—and some of the proposed solutions are quite creative, indeed. For instance, instead of paying their local property taxes, New York allows taxpayers to simply make a comparable charitable contribution to a charity set up by their local school district. Presto! What used to be a tax is now a charitable contribution that is deductible for taxpayers who itemize. The state would also allow New York City and other municipalities to set up their own charitable trusts, converting local taxes into deductible charitable contributions as well.
Even more creative: California’s Senate Bill 227 would create something called the “California Excellence Fund,” which would provide a credit against state income tax liability for any contributions to the fund—effectively recharacterizing as much of the state tax liability as the resident wants into deductible charitable donations. Similar legislation has been introduced in Illinois, Nebraska and Virginia. In Washington state, which doesn’t levy an income tax, a copycat bill would let taxpayers make charitable contributions to the state and receive a sales tax exemption certificate in return.
Is any of this legal? We don’t know yet. The IRS has recently issued a broad warning against states’ creative use of charitable contributions, and it never helps a future tax court case when lawmakers openly tout their intentions to evade federal tax law when they introduce state legislation. Still, tax experts note that the IRS has provided favorable rulings in more narrow cases regarding the federal deductibility of state tax credits in 33 states.
For instance, Alabama has, for years, provided a 100% state tax credit for taxpayers who donate money to organizations that give children vouchers to attend private school. New York’s new SALT-related provision would give an 85% state tax credit to residents who donate to a local charitable fund that supports education. Is one legit but the other not? Stay tuned! The IRS will surely have something to say about it.
In the meantime, we’ll continue to use our creativity and ingenuity to help our clients keep as much of their hard-earned income in their pockets as possible!