The Tax Cuts and Jobs Act (TCJA) of 2017 constituted one of the most sweeping tax reform laws in nearly three decades. But while many taxpayers are excited to take advantage of lower tax brackets and higher standard deductions, those in states with high property tax rates are concerned about the new cap on deductibility of state and local taxes (SALT). In response to this concern, several states, including New York and New Jersey, have enacted SALT workarounds for the 2018 tax year—but a recent IRS notice may have put the kibosh on any attempts to reduce taxpayers' federal tax liability. Read on to learn more about how states are attempting to maintain SALT deductibility and how the IRS plans to respond.
Why the SALT Workarounds?
Before 2018, the SALT deduction allowed high-tax states to reduce the burden on their taxpayers through the generous federal deduction. For example, a taxpayer who paid $14,000 in property taxes each year could deduct this amount from their federal taxable income, essentially shielding these funds from taxation.
But the SALT cap now limits all state and local tax deductions to $10,000, which operates as an immediate tax increase for anyone in a high-tax state who was previously deducting more than that amount. While some relief may be found through lower tax brackets and an increased standard deduction, legislators from high-tax states argued that this provision was designed as a political ploy to punish taxpayers in traditionally Democratic strongholds.
In an effort to permit taxpayers to continue their former SALT deductions (and to avoid losing high-income taxpayers to other, lower-tax states), several states quickly enacted measures to reduce the impact of the SALT cap. Because charitable contributions continue to be fully deductible, New York proposed that taxpayers make their property tax payments to a municipal charitable organization in lieu of paying property taxes to the county auditor. By paying property taxes to a local library fund instead of a government official, taxpayers could fulfill their local tax obligations without losing the SALT deductibility.
Other states have created new 501(c)(3) nonprofits that are designed to essentially take over the collection and enforcement of property taxes and other state and local taxes.
The IRS's Response
The IRS quickly responded to news of the proposed SALT workarounds and issued a stern decree earlier this year. It indicated that, despite what states may say (or do), it retains the ability to look at the substance and purpose of various tax transactions, not just the form of these transactions. Any transactions that appear to be performed as a tax dodge (or as a way to gain greater deductions than would otherwise be available) may be disallowed by the IRS, which could leave taxpayers facing hefty bills and even underpayment penalties in the event of an audit.
Depending on the number of state taxpayers who take advantage of the SALT workarounds, the IRS may begin disallowing all charitable contributions to certain organizations instead of initiating an audit in any suspicious cases.
What Should Taxpayers Do?
Given the IRS's quick response to the proposed SALT workarounds, taxpayers who take advantage of these workarounds likely do so at their own risk. It's always possible that taxpayers won't be audited or assessed extra taxes, especially given the multiple changes the TCJA has created, but using municipal charitable contributions to deduct more than $10,000 in SALT is likely to ensure your tax return will face greater scrutiny than others. And taxpayers from states with highly publicized SALT workarounds may already have an uphill battle when it comes to having their returns accepted without this higher scrutiny. If you're unsure about whether certain expenses and taxes remain fully deductible in 2018, it's best to contact a company that offers accounting services for more information.Share