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07/09/2019
U.S. Treasury Issues Final Regulations Restricting SALT Deduction Workarounds
On June 11, 2019, the U.S. Department of the Treasury published final regulations (T.D. 9864) addressing the federal income tax treatment of payments made under the state and local tax (SALT) cap workarounds enacted by various states in response to $10,000 SALT deduction limit imposed by the Tax Cuts and Jobs Act of 2017 (TCJA). Specifically, the regulations aim to prevent charitable contributions made in exchange for state tax credits from circumventing the new SALT deduction limitation. The final regulations largely adopted the proposed regulations published Aug. 27, 2018.
Summary of the final regulations
Under the TCJA, federal income tax law now limits the itemized deduction for state and local taxes paid during the calendar year to $10,000 for individual taxpayers ($5,000 for married filing separately). The loss of the full SALT deduction has been controversial and has led many states to consider alternative methods to preserve deductibility for their residents. For example, among other avenues, New York created various charitable gift trust funds, in an effort to enable individual taxpayers to make charitable contributions to the state for health care and education spending. Taxpayers who made contributions to these funds would in return receive a tax credit equal to 85% of the donation amount against their state and local tax liabilities. Subsequently, such taxpayers could then treat the donations as fully deductible charitable contributions on their federal tax returns – charitable contribution deductions are not subject to the same $10,000 cap.
The recently issued final regulations aim to prevent this technique from working by seeking to apply long-standing quid pro quo principles. Under these, when a taxpayer receives a benefit in return for a charitable donation, the taxpayer can deduct only the net value of the donation as a charitable contribution. For example, if a state grants a 70% state tax credit and the taxpayer pays $1,000 to a charitable organization, the taxpayer will receive $700 in state tax credit. The taxpayer must then reduce the $1,000 contribution deduction by the $700 state tax credit, leaving $300 of allowable charitable contribution deduction for federal income tax purposes.
The final regulations further provide safe harbor exceptions for dollar-for-dollar state tax deductions as well as for tax credits of no more than 15% of the amount contributed. In other words, a taxpayer who receives a state tax deduction of $1,000 for a contribution of $1,000 is not required to reduce the federal charitable contribution deduction to take into account the state tax deduction. Further, a taxpayer who makes a $1,000 contribution is not required to reduce the $1,000 federal charitable contribution deduction if the state or local tax credit received or expected to be received is no more than $150.
The final regulations are effective Aug. 11, 2019, and apply to contributions made after Aug. 27, 2018.
What does CohnReznick think?
The loss of the full SALT deduction could have a significant impact upon taxpayers, especially wealthy taxpayers, in high-tax states such as New York, New Jersey, Connecticut, and California, among others. As a consequence, individual taxpayers may be considering various tax-planning strategies to mitigate the potential effects. High net worth taxpayers, for example, are often mobile and may consider changing their tax residence. A residency change, though, requires careful planning and strict attention to detail. Residency audit defense, too, requires a nuanced understanding of the applicable rules. Accordingly, taxpayers should proceed with caution and seek professional advice when facing a residency change planning question or, worse, a residency audit question.
Corey Rosenthal
JD, Principal, Practice Leader, State and Local Tax (SALT) Services
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