How Does the Revised SALT Cap in House OBBBA Work?

On May 22, the House passed H.R. 1, the One Big Beautiful Bill Act (OBBBA), and it now goes to the Senate Finance Committee where changes will occur. Some of the House provisions will need to be removed due to the Senate using the Budget Reconciliation Process which calls for restrictions on the nature of the changes, such as they must deal with revenues. And, the Senate will have different ideas on what is currently in the bill which includes over 40 tax changes and some non-tax provisions.

One item of contention among members of both parties is whether to keep the TCJA $10,000 SALT cap that expires at the end of this year. This is an important provision because it could cause the bill to not get enough votes to pass so compromise is likely. The House bill will increase the cap but adds a lot more, particularly to IRC Section 275, Certain Taxes. This rule is in Part IX of Subchapter B of Chapter 1 of Subtitle A or Title 26 (IRC); Part IX is titled Items Not Deductible. With the TCJA, the SALT cap was at IRC Section 164(b)(6) and was brief.

Where a legislative proposal or public law makes changes to various parts of an existing Code section, I often find it helpful to create a track changes of the affected Code sections to get a better understanding of the changes.  I have created such a document for the House's SALT changes which you can find in this 18-page pdf with changes shown using track changes.  Part of the reason it is long is because I include all of Section 164 despite few changes to it in order to get a better understanding of the changes to Section 275. The SALT cap changes also change a few partnership provisions.

I wish I could explain here how the SALT cap changes work, but I still need more time to figure it all out as the changes are a bit intertwined with other Code sections and H.R. 1 changes. This change does not meet the principle of simplicity!

If you have figured it all out I applaud you! Please leave comments to help us all out. 

It is likely that the Senate and Conference Committee will continue to make changes.

What do you think?

5th Anniversary of Tax Cuts and Jobs Act - 12/22/22

The Tax Cuts and Jobs Act (P.L. 115-97) was signed into law on December 22, 2017. This was a budget reconciliation bill so only needed 51 votes in the Senate rather than 60. Among many things, this means the official name of the bill has the word "reconciliation" in it (an act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018).

The TCJA was primarily intended to make the corporate tax system more internationally competitive by lowering the corporate rate (from a high of 35% to a flat 21%) and make the international system a semi-territorial one rather than worldwide.  But, not all businesses operate as C corporations and the TCJA included the §199A qualified business income deduction to provide a rate reduction for business income of sole proprietors, partners and others, with a few exceptions. But that provision is only in the law through 2025 while the 21% corporate rate is permanent (pending any congressional action to change it).

There are many temporary provisions in the TCJA, several of which are built-in tax increases. Here is most of that list.

• Beer, wine and distilled spirits – special rule on interest capitalization (§263A(f)(4) and excise tax rates was to expire 12/31/20 but was made permanent by CAA-21 (PL 116-260; 12/27/20).
• §45S, Employer credit for paid family and medical leave, terminated for wages paid in tyba 12/31/20, but was extended 5 years by CAA-21 (PL 116-260; 12/27/20) (to 12/31/25).
• Staring in tax years beginning after 12/31/21 businesses with R&D must capitalize their total R&D expenditures (§174) each year and amortize them over 5 years using the half-year convention (15 years for foreign research).  This is a BIG change since expensing has been the law since 1954. The effect is significant. For example, if a business had $100,000 or domestic R&D in 2022, rathe rather than expensing $100,000 in 2022, they can only expense $10,000 in 2022 and the balance is expensed (amortized) over 2023 to 2017).
• The §163(j) interest limitation calculation becomes less favorable for tax years beginning after 12/31/21 (depreciation, amortization and depletion will reduce adjusted taxable income).
• 100% bonus depreciation of §168(k) begins to phase down generally for property placed in service after 12/31/22 through 12/31/26. For 2023, it will be 80% bonus.
• The deduction for foreign-derived intangible income (FDII) and global intangible low-taxed income (GILTI) are reduced from 37.5% to 21.875% for FDII and from 50% to 37.5% for GILTI for tax years beginning after 12/31/25.
• Individual provisions expire after 2025 such as doubled child tax creidt, higher standard deduction, lowered brackets, SALT cap.
• The §461(l) business loss limitation for non-corporate taxpayers expires after 2028 (years changed to 2021 through 2028 by a few post-TCJA public laws).

If there are to be any changes to TCJA now or in very near future, I'd recommend:

1. Repeal the §174 change. It is simpler and better encourages R&D to allow for it to be expensed when incurred.
2. Remove the SALT cap for state and local taxes attributable to business income such as is on Schedules C, E and F. These business taxes should be deductible FOR AGI.
3. Make the Child Tax Credit fully refundable. 
4. Repeal the individual AMT.

What do you think?

Passthrough Entity SALT Cap Workaround is Messy!

Note: Additional text added 12/1/21 after initial posting.

The $10,000 SALT cap enacted as part of the Tax Cuts and Jobs Act of 2017 has policy flaws. I have written about this a few times in recent years (7/4/19, 9/21/18) and in a few AICPA comment letters I signed as chair of the Tax Executive Committee (such as 11/10/17). The policy flaws include:

1. Why are C corps the only business entity allowed to fully deduct their state and local business taxes? State and local taxes are a normal expense of any business so should be deductible in computing taxable income. The reason non-C corp businesses (and their individual owners) are subject to the SALT cap even on state and local income taxes on business income is a 1944 law that made such taxes deductions from AGI rather than for AGI and Congress didn't fix that in 2017 when it added the SALT cap. This should be fixed.

2. There are good arguments to be made that all taxes should be deductible from income as they are mandatory payments. But, here, I think a limit makes sense. The TRA'86 removed the deduction for sales tax although the original proposal was to remove the personal deduction for all state and local taxes, because sales tax ties to personal consumption. There is a lot of logic to that. That same logic applies to personal and real property taxes too. If someone wants to own 10 homes, why should everyone else subsidize the property taxes on it? I posit that the Schedule A deduction for property taxes should be limited to what they would be on a 1400 square foot home at the median price in that region.

So, we start with flaws in just having a $10,000 cap.

The policy flaws were made worse with Notice 2020-75* that allows even elective taxes that a state imposes on a partnership, S corp or LLC to be treated as an entity tax for federal purposes despite most states that have recently enacted these taxes treating the taxes as a tax credit for owners.  Basically, the entity is paying the state income tax on behalf of the owners with that tax moving from Schedule A to Schedule E where there is no SALT cap. This works for partners and S corp shareholders in states that have enacted these taxes. It does nothing for individuals hitting the SALT cap due to wages, investment income, sole proprietor income and real property taxes on their home.

   [*Yes, it was good that Treasury and IRS tried to fix a flawed law to start with.]

I don't disagree with the Notice 2020-75 statement that a tax imposed directly on a passthrough entity (PTE) and not separately stated for the owner is an entity tax, just the reason why we should have a workaround for elective taxes and just for passthroughs. Of the roughly 20 states that have enacted these entity income taxes, it is only a mandatory tax in Connecticut.

The elective PTE regime in about 19 states has led to a lot of compliance challenges because the PTE taxes are different among the states as to how to elect and pay, whether any owners can opt out or are not eligible, what income is covered, whether the tax applies against the owner's state tentative minimum tax, the rate, and more.

And these challenges can also raise issues on how they interact with other income tax rules. For example, California's PTE (added by AB 150), is elective. The entity can't elect though until it timely files its return. However, the entity can pay the tax before then using Form 3893 which the FTB recently released. Also, owners (if qualified) must consent to the tax, and the entity just pays the 9.3% tax on the income of the consenting owners (that is an odd entity level tax!).

I think the payment form was released early so owners could get the federal tax benefit of the PTE tax on their 2021 return (the tax isn't due until 3/15/22 for a calendar year entity). BUT what about accounting method rules and the definition of a deposit? If the PTE tax is paid by 12/31/21 but the entity doesn't make the optional election, then the tax is refunded. This means that any payment before the election is really a "deposit" and "deposits" are not deductible.

A payment is a deposit under the USSC Indianapolis Power & Light case if the payor is not fully on the hook to take the action related to the payment (such as buy power) and has "complete dominion of control" over the funds. Since the entity can get the tax payment back until the time when it makes the irrevocable election, it doesn't look like the entity can deduct the PTE tax paid in 2021 on its 2021 federal 1065 or 1120S, meaning it won't be on the federal K-1 for 2021.  It would still be a 2021 item for California purposes, but the federal benefit would not occur until 2022 when the election is made.

Beyond the deposit issue, an accrual method entity has an issue with the all events test of §451 in that there is a contingency that the tax isn't really owed by the entity until the election is made and that can't be made until 2022. I don't think a signed statement from all consenting owners helps because the entity could still not elect or not get it timely made.

Now, we don't yet have any regs from the IRS that were promised but I doubt the IRS would write them contrary to the law on deposits and the all events test of §451, but you never know. Perhaps for states with a PTE tax regime like California's they would allow payment to be treated as enough to make the entity liable in the year paid.

No doubt, there is ambiguity and we don't have IRS regs. It is interesting that Notice 2020-75 uses terms payment, paid and made rather than "paid or incurred" which might imply that normal accounting method rules are overridden. Consider this from Notice 2020-75:

"Deductibility of Specified Income Tax Payments. If a partnership or an S corporation makes a Specified Income Tax Payment during a taxable year, the partnership or S corporation is allowed a deduction for the Specified Income Tax Payment in computing its taxable income for the taxable year in which the payment is made."

But also consider that a Specified Income Tax Payment is defined as any amount paid by the entity "to satisfy its liability for income taxes imposed by the Domestic Jurisdiction" on the entity. In California for 2021, it appears that without an election, there is no liability for the tax, and the election can only be made on the 2021 return (R&T 19900(d)) and if not made, the tax payment is refunded (R&T 17052.10(d)). Perhaps payment can be enough to get the deduction at that time under an argument of why make the effort to get owner consents and estimate and pay the tax if the entity does not intend to elect on the return? Also, might the payment voucher FTB Form 3893 be considered part of the return (although it is only a payment voucher and not the election statement)?

What a lot of complexity and confusion when considering tax policy and the proper treatment of state and local taxes for individuals years ago could have resolved the issues of the proper treatment of state and local taxes on Form 1040 (the issue was raised before TRA'86 - see page 62 of 1984 Blueprints for Tax Reform Vol 2). Hopefully someday we'll see that policy discussion and an improved federal tax treatment of SALT.

#letsfixthis

What do you think?

We Need More Tax Policy Discussion

We have a few proposed changes under consideration that very much need a deep policy discussion rather than only a cost estimate and a general like or dislike. Here are three such items:

1. What is an appropriate phase-out rule for the next economic impact payments? The current ones cause a credit to still be allowed for high income taxpayers who have a few children. The CASH Act (H.R. 9051; 116th Congress) that the House passed late 2020, called for EIP of $2,000 including for dependents. If a married couple has 4 dependents, they credit would be $12,000. The phaseout rule would not cause this entire credit to reach $0 until AGI reached $390,000!  That is not an income level in need of assistance typically.

2. Should the TCJA be made permanent? On 12/22/20, Senator Grassley sent a letter to President-elect Biden suggesting this. While this could be done with a single piece of legislation, it really needs major tax policy discussions. This should include what the goals were of the TCJA beyond the need to reduce the corporate tax rate and move the international tax system for businesses to be more territorial rather than worldwide. Examples of things to discuss:

• What is the proper rate structure for all buisnesses and individuals. For individuals, a discussion of progressivity and relevance for capital gains and ordinary income as well as looking at the impact at each quintile as well as top 1% and further breakdown that top 1% given the income range from 6 figures to 9 figures.
• Besides the rate, the base is crucial. What are appropriate deductions and exclusions and phaseouts for any of them?
• The TCJA denied deductions to employers for certain employee fringe benefits. Seems the more appropriate policy is to allow the business to deduct its normal business expenses and any desire to have wage income equal wage deductions should be done via repeal of certain fringe benefits. Also, transparency and accountability are missing from one of these changes - the denial of a deduction by an employer providing qualified transportation fringe benefits. Why wasn't that prohibition put in section 162 or at a new section 280I? Placing it in section 274(a)(4) makes the exceptions at section 274(e) applicable so some of these QTF expenses are actually deductible.
• And there is more.  And just a reminder that for the Tax Reform Act of 1986, there were extensive reports written in advance and lots of hearings (for about a year).

3. Should the TCJA $10,000 SALT cap be changed and how? The policy discussion need to include is the point of limiting all taxes of individuals? This is not a new topic as denial of the deduction was proposed back with the Tax Reform Act of 1986. The current SALT cap includes state and local income taxes that sole proprietors and partners pay on their business income even though corporations have no such limitation. Such taxes should be a deduction for AGI. A common argument about tax deductions is that they are mandatory payments. That is true, but some have some optional aspects to them. For example, if someone buys a very large home or a second home, that is their choice. Why should they deduct all of their property taxes? That deduction can be limited to the property taxes on a median priced/sized home for that county and just one home. These are just examples of some of the discussions needed here. This makes more sense than writing regs and encouraging states to enact optional or mandatory income taxes on partnerships and S corporations which the IRS has said it will treat as above the line even though the owners still report the income on their federal income tax return. [See Notice 2020-75]

What do you think?

Fixing the SALT $10,000 Cap

Source: JCX-35-19 (6/24/19) for the House Ways and Means Committee hearing on problems with the SALT cap.

On June 25, 2019, the House Ways and Means Committee held a hearing on the SALT cap with the majority's views on it clear from the title of this hearing: How Recent Limitations to the SALT Deduction Harm Communities, Schools, First Responders, and Housing Values. Testimony was provided by some state and local elected officials and the Tax Foundation.

I agree that this is a flawed provision that was addressing what was already a flawed provision. There were no hearings held for the Tax Cuts and Jobs Act so it was difficult to get broad input into the process.  The AICPA Tax Section did submit a few letters during this process including one that made a very important point. If individuals would have a cap on their state and local tax deduction when claimed as an itemized deduction, an additional change had to be made to treat all business entities the same. Since a C corporation continues to get to deduct all of the state and local income taxes it pays, so should a sole proprietor, partner and S corp shareholder. That could have been accomplished by making a change to a 1944 law to allow state and local income taxes on that business income to be deducted above the line (for AGI) rather than only as an itemized deduction. [See AICPA letter of 11/21/17 and letter of 9/25/18 submitted when the House was discussing Tax Reform 2.0]

My observations regarding the policy of deducting state and local taxes:

1. There should be equity among different types of business types (see above paragraph).
2. Prior to the TCJA, only 30% of individuals itemized deductions and many of these folks lost their SALT deduction due to owing AMT. Thus, this was not a widespread deduction.  Many elected officials including governors of New York and New Jersey have issued statements since the change was introduced in fall 2017 that make it sound as if all of their residents are losing a big deduction. But, again, prior to the TCJA, less than 30% of individuals deducted their personal SALT.
3. Why allow a deduction for state and local taxes not related to a business? After all, there are lots of personal expenditures we can't deduct such as car insurance, 100% of child care, 100% of tuition, and lots more. Well, one argument is that you must pay state and local taxes so it does represent dollars not available for paying federal taxes. But, this is not completely true.  For example, if Jane decides to buy a large home for $1 million rather than a modest one representing the median home value in Jane's area of $300,000, she will owe more property tax. Should she be allowed to deduct property tax on the $1 million home which is far above the median home price in her area?
   
   Bear in mind that special tax rules (deductions, exclusions, credits and favorable lower tax rates) reduce someone's taxes with the "cost" borne by others.  Why should others bear the cost (tax deduction) of Jane's decision to buy a more expensive home than the median home price. A great example of an extreme on this is evidenced by Mitt Romney's return for 2011 showing he paid property taxes on his personal residences of $214,728.  I'm not singling him our to pick on him, it is just that his return is publicly available from when he ran for President and voluntarily disclosed it. Many high income/high wealth individuals own multiple homes of high value and thus pay a lot of property tax. Many of these high income individuals also used to get a full deduction for these taxes before the $10,000 SALT cap because their regular tax rate was high enough to not be subject to AMT. [Thanks to Tax Notes (and the candidates and elected officials) for making these returns available to the public.]
   
   Note: Limit or repeal of the SALT deduction is not new. It was addressed in Treasury's 1984 Blueprint for Tax Reform which led to the Tax Reform Act of 1986 and repeal of the sales tax deduction. For more, see my May 2008 article - here.
4. Repeal of the SALT cap will provide a significant benefit to high income individuals. After all, it's a deduction and bigger deductions reduce taxes the most for individuals in high tax brackets. Per data from the Joint Committee on Taxation released for the June 25 hearing (JCX-35-19, Table 4), for 2019, repeal of the $10,000 SALT cap would reduce individuals' taxes by $77.4 billion with $40.4 billion of this savings going to individuals with income over $1 million (less than 0.5% of the public). All told, $73 billion or 94.3% of the benefit would go to individuals making over $200,000 of income.

It is puzzling why so much attention is being paid to repealing the $10,000 SALT cap (and mostly from Democrats who tend not to be fighting for additional tax cuts for high income taxpayers), rather than taking a policy perspective to reforming this flawed deduction and cap.  And better yet, why not look at other weaknesses in our tax system as well, and work to fix them, with the result that we'd have a more understandable (simpler) and equitable system, most likely with lower rates.

I suggest that for fairness and equity and better ability to keep rates low, as part of reform of the SALT cap that it be replaced with a cap on Schedule A property taxes to only allow a deduction for property taxes on a principal residence costing 110% of the median home price for the area. In addition, state and local income taxes attributable to business income should be deductible above the line (for AGI) just like a C corporation is allowed to do. Property taxes on business property (including rental property) would continue to be deducted above the line as they have been in the past (and still today). And the individual AMT should be repealed so there is just one set of rules rather than two with two tax calculations.

What do you think?

Latest Guidance on SALT Cap and Donations + Notice 2019-12 Safe Harbor

Excerpt from 2018 Form 1040 Schedule A, Itemized Deductions

The $10,000 cap on itemized deductions of state and local taxes led a few states to add new "workarounds" such as offering a credit that would reduce state taxes (where the deduction is limited) and converting it to a federal charitable contribution (which is not limited (well it is, but only when donations exceeds about half of your income)). For example, since 2014, California's College Access Fund takes donations for which the donor gets a 50% credit against their California income tax. On the federal returns that means a charitable contribution for the full amount and a reduced state tax deduction since the credit reduced the donor's state taxes.

Prior to the Tax Cuts and Jobs Act, at least 18 states had these credit donation arrangements with credits up to 100%, mostly for donations for scholarships to private schools (see Sept. 2018 GAO report). The benefits are funding scholarships, shifting tax dollars to private schools rather than only public schools, and providing a tax break to donors who owe alternative minimum tax (AMT).

After the TCJA, Treasury said it would issue regs to limit the benefit of these credit schemes, taking a substance over form approach in the guidance (Notice 2018-63 (8/3/18)). Proposed regulations were issued in late August 2018 (REG-112176-18 (8/27/18)) & IR-2018-172 (8/23/18)) that basically require the donation to be reduced by the state tax credit claimed or available unless that credit was 15% or less of the amount transferred to the state or local government. This treatment applies to donations made after 8/27/18, regardless of when the state/local tax credit regime was created. Treasury Secretary Mnuchin also issued a press release on 8/23 about the regulations and intent.

IRS received over 7,500 comments on the proposed regs. Per the IRS, 70% of the comments favored the approach of the regulations (see IR-2019-109 (6/11/19)). The final regs (TD 9864 (6/13/19)) follow the proposed regs.

The IRS also issued a proposed safe harbor effective starting for 2018 that provides a benefit to a donor receiving a state or local tax credit but who has deductible state and local taxes below the $10,000 deduction cap. Individuals who can benefit and who have already filed can file an amended return. The IRS expects the proposed safe harbor to be added to proposed regulations it will issue on the new $10,000 SALT cap.

I didn't find the notice to be entirely clear, but piecing together how it is described in the preamble to the final regs (TD 9864 (6/13/19)) and the suggested rationale for the safe harbor, I offer the following interpretation and examples.

[assumes both Anne and Ben have itemized deductions greater than standard deduction]	Anne - Donates to state charity and receives 60% state tax credit	Ben - Donates to Red Cross for which regular deduction rules apply
Amount donated	$1,000	$1,000
Amount disallowed under §170	$600	$0
Total SALT before state credit	$8,000	$8,000
SALT after state credit	$7,400	$8,000
Charitable donation allowed	$ 400	$1,000
Aggregate Schedule A deduction for SALT and donations	$7,800	$9,000
Schedule A with the safe harbor	$8,400 ($7,400 + $400 + $600)	$9,000 (safe harbor n/a)

While it may seem that the Ben is better off than Anne in this example, Anne paid $600 less of state income tax than did Ben. Looking at cash flow, they are in the same situation.

If the individual were already above the SALT cap, treating the amount disallowed as a charitable contribution as a SALT deduction is of no benefit. Thus, the safe harbor is only helpful to an individual below the SALT cap who also donates to a charity that yields a state or local tax credit.

Meanwhile, a lawsuit (No. 18-CV-6427) filed by Connecticut, Maryland, New Jersey and New York in July 2018 has oral argument on June 18, 2019 in the Southern District Court of New York. I don't expect the states will win on their position that the SALT cap is illegal or that it was politically motivated. There are several deduction prohibitions and limitations in the law and political motivation is likely tough to prove.

What do you think?

TCJA Reference to 1944 Law Regarding SALT Cap is Now Online

Santa Clara County Law Library - great place and free - has the 1944 Cumulative Bulletin!

In describing the new $10,000 deduction limit for personal state and local taxes that was added by the Tax Cuts and Jobs Act (P.L. 115-97; 12/22/17), the committee report at footnote 168 refers to a page from the 1944 Cumulative Bulletin (CB) regarding a 1944 law change. To help understand what they were getting at, I recently tracked down that 1944 page.

This is a reminder of a few things. First, not everything is on the Internet.  While there might be a copy of the 1944 legislation available on an online database somewhere, likely not for free access (I could not find it). But the CB is really needed because footnote 168 refers to a specific page for its support of a statement about the present law (pre-TCJA law). I pulled the CB from where the Santa County Law Library (free to public) stores its old government publications (in the attic!) (Note: the photo above shows first and second floors, there really is an attic above that.)

But - now that page from the CB is on the Internet - click on Section 164 from this 1/2/18 post where I have links to a few track changes versions of Code sections changed by the TCJA. The Section 164 link will also take you to the committee report.

Second, the 1944 law is a reminder that when Congress created the concept of Adjusted Gross Income (AGI) in 1944, they described where state and local taxes are deducted (for or from AGI). For property taxes paid by your sole proprietor business for example, they are deducted for AGI because they are paid and imposed directly on the business. In contrast, state income taxes imposed on that business are deducted from AGI as they are remotely connected to the business income. Basically, I think the concept is that when an individual calculates their state income taxes that calculation involves all of their income, various deductions, exclusions and credits. How much of that state income tax is attributable to the business income?

This is why for decades, state income taxes go on Schedule A rather than splitting it among other schedules, such as C, E, and F. In contrast, property taxes paid by a business, partnership or farm are deducted above the line (as part of one of these schedules).

This was also an issue after the Tax Reform Act of 1986 when tax prep fees became subject to the 2%-of-AGI threshold. People asked - what about the tax prep fee attributable to my Schedule C sole proprietor business? Despite the treatment of state and local income taxes, the IRS determined that the tax prep fee could be allocated (see Rev. Rul. 92-29).

Also, old IRS rulings determined that in calculating a net operating loss (NOL), the state and local income taxes attributable to business income can be part of that NOL (Rev. Rul. 70-40). Thus, there are ways to measure that (there are ways to measure most things).

The $10,000 state and local income cap (also referred to as the SALT cap), is in the law from 2018 through 2025. The House Ways and Means Committee voted to make it permanent, along with other temporary individual provisions including the reduced tax rates), on 9/13/18 (HR 6760). It is unlikely the Senate will vote on this as it would take 60 votes there to pass.

Final point while I'm talking about the $10,000 SALT cap, why not change the law to allow individuals to deduct their state and local income taxes attributable to their business income above the line?  Certainly with the $10,000 cap, this seems like the right thing to do. After all, corporations don't have a cap on their state and local income tax deduction, why should individuals operating a business outside of the corporate form have a limitation. And even without the cap, deducting for AGI makes sense because not all business owners itemized.  The AICPA recommended this change while the TCJA was being discussed in Congress (which was the first time the SALT cap came up) (see item 4 in this 11/2/17 letter to Congress and this 11/13/17 letter and 11/10/17 letter).

What do you think?

State Bewilderment to TCJA - Podcast Too!

A State Tax Notes article of mine for 5/28/18 is titled, "Moving Past a TCJA State of Bewilderment." My focus is on a few states, notably, New York, where the governor and a few others made statements implying that the Tax Cuts and Jobs Act would harm the state and its residents.  Yes, some will pay more, but the vast majority will see a tax reduction.

Many new rules are at play including ones that may result in loss of deductions, such as capping the state and local tax (SALT) deduction to $10,000, but many will get new deductions, such as if they are self-employed or have rental income (the "199A deduction"). And the rates go down for everyone.

We are seeing some states enact workarounds to the SALT cap, including New York and New Jersey. Connecticut just enacted (SB 11) a new tax on partnerships and S corporations with a credit given to the owners - that starts now! (See information from CT Dept. of Revenue.) That's an interesting workaround. The IRS plans to issue regulations on whether these workarounds, including ones to donate money to a state fund to get a federal charitable contribution deduction and a state tax credit, work (Notice 2018-54).

I recently had the opportunity to record a "Simply Tax" podcast with BKD's Damien Martin on this topic - state tax workarounds (6/7/18).  Or see link on Apple Podcasts or link on YouTube. You can also find links to over 30 terrific podcasts Damien has produced on various tax topics - many on TCJA provisions.

What do you think? Should states be truly worried?

Yet One More Proposal for Relief of New State Tax Deduction Cap

The Tax Cuts and Jobs Act (PL 115-97; 12/22/17) limits the itemized deduction for state and local taxes to $10,000 ($5,000 if married filing separately). As with most of the individual tax changes including the lowered tax rates, this change only exists for 2018 through 2025.

Several states don't like this change, particularly states like New York, New Jersey and California with high state taxes. New Jersey enacted S 1893 on 5/4/18. It allows local governments to create funds where property owners can "donate" to the fund and get a 90% credit against their property tax. The federal benefit is that this is a charitable donation which shows up on the federal return as a charitable deduction rather than as a state tax deduction. Sounds like a good deal.  Too good to be true?

Perhaps now that a state has enacted such a law (although local governments still need to create the funds), Congress or the IRS will step in to let us all know if this works. While similar state tax credit funds have been around for a while, the state credit amount is usually lower. The problem is that if the "donor" gets a big benefit from the donation, was it really a charitable donation?

Other versions of this type of proposal are at the state level, such as California SB 227 which creates the California Excellence Fund. Donors get an 85% state tax credit. SB 227 passed in the Senate on 1/30/18 and is awaiting attention in the Assembly.

But California has one more proposal - AB 1485. This proposal has limited effect compared to other bills. This bill allows a 100% credit against an individual’s California income tax for a contribution to a charity located in California. The credit maximum is $500 ($1,000 for MFJ). No California deduction is allowed for the contribution. The stated goal is “to ensure California creates a robust and efficient tax incentive program that encourages all Californians to contribute to the charitable organizations serving their communities, coupled with accountability and transparency measures. Towards this end, California’s tax credit for charitable donations ensures that California taxpayers receive the maximum possible economic return on their investment and creates overall positive and sustained economic impacts for the entire state.” The bill’s effectiveness is to be judged by the number of taxpayers who claim the credit.

Critique: Unlike other proposals, such as SB 227, AB 1485 has a dollar limit. Also, the purpose might not be realistic because while for California tax purposes, the donor comes out even, if the individual does not itemize for federal purposes, there is no federal tax benefit of the donation. If the donor does claim a federal deduction, it's a great expenditure for the taxpayer because the benefit exceeds the cash outlay. For example, if the donor is in the 32% federal bracket and donates $1,000 (MFJ), they save $1,000 of California taxes and $320 of federal taxes - all for a $1,000 outlay!

AB 1485 provides a benefit to California taxpayers who do not itemize as they will get a tax benefit for their contribution (if to the right organization). 

How does the state pay for the likely high cost of AB 1485? Seems they will have to cut costs such as for social programs and perhaps even education. Will the donations go to charities that will make up for these cuts? I don't think so. Some of the donations will likely go to churches and public (and private) schools as they are clearly located in California. More of the donations will be make by higher income individuals as they have the money for the donations. Basically, AB 1485 allows taxpayers to use their tax dollars to decide which charity or cause to support rather than elected officials deciding where those tax dollars are needed.

The FTB likely needs to define what it means to be a charity located in California and how a donor can tell (such as distinguishing a PO Box from an actual location). Also, why not say that the charity has to provide a certain portion of its benefits to Californians (or that is qualifies for a property tax exemption in California since the charity could note that on its website and the FTB can verify that). Clarification is needed on whether a charitable contribution deduction continues for donations above $500 ($1,000 if MFJ).

Will these provisions work? What if individuals use them and then Congress or the IRS says no? I don't think it is a problem for AB 1485 as the donations are clearly to charities (although that can include governments). SB 227 which finds the General Fund is a bigger concern. It is basically replacing tax payments with "donations". It donations to the state fund are not enough, it won't affect government operations as they will still have tax dollars to meet budget needs.

What do you think?