Yesterday, the IRS proposed rules that prevent states, including New Jersey, from using a State and Local Tax (SALT) cap workaround. The workaround allowed residents to avoid a $10,000 SALT deduction cap imposed by the Tax Cut and Jobs Act.
Earlier this year, in response to the deduction cap, New Jersey enacted legislation allowing local governments to set up charitable organizations to accept property tax payments. Taxpayers who donate to such charitable organizations could receive up to a 90% state tax credit and write off such donations on their federal taxes. In effect, this allows taxpayers to receive a state tax credit and then a federal tax deduction by converting their property tax payments into charitable contributions, thereby circumventing the $10,000 SALT deduction cap.
However, on Thursday, August 23, the U.S. Department of Treasury (Treasury) threw cold (SALT) water on the workaround. Although New Jersey may continue to give state tax credits for charitable contributions, those who donate will not be allowed to deduct such charitable contribution amounts from their federal tax returns. Specifically, the Treasury’s proposed rules require taxpayers who itemize their deduction to reduce their charitable contributions by the amount of the state and local tax credit received. For example, if a New Jersey taxpayer makes a $25,000 charitable donation to pay property taxes and receives a $22,500 state tax credit (90% of charitable donation amount); the taxpayer would only receive a $2,500 federal tax deduction (the difference between the donation amount and state tax credit).
This new requirement would also apply to preexisting SALT credit programs, such as state tax credits for donations to charities and schools. The Treasury said that the federal government could not reasonably distinguish between the SALT workaround schemes and preexisting SALT credit programs. Accordingly, taxpayers who receive SALT state tax credits for their donations to charities or schools will also be precluded from deducting their charitable contributions.
The proposed rules, however, provide for a de minimis exception. Under this exception, if the SALT tax credit does not exceed 15% of a taxpayer’s charitable contribution, then the state tax credit does not reduce the federal deduction available to the taxpayer for the contribution. In such instance, a taxpayer can deduct their full charitable contribution on his or her federal tax return.
In response to the IRS's proposed rules, it seems that high taxing states, such as New Jersey, are likely to challenge the proposed SALT deduction disallowance rules. As evidence of same, New Jersey Governor Phil Murphy issued a statement on Thursday evening indicating that the state will examine “all legal avenues” for a challenge.
Parker McCay will continue to monitor developments on these proposed rules and provide updates to taxpayers and municipalities on new developments. In the interim, please contact the attorneys in Parker McCay's Corporate Department with questions about the implications these proposed rules may have on your tax liability.
The content of this post is for informational purposes only and should not be construed as legal advice or legal opinion. You should consult a lawyer concerning your specific situation and any specific legal question you may have.