If You Don’t Like the New Tax Reform, Find a Way Around It

With the new tax reform, there were winners and losers. The biggest losers were the individual taxpayers that lost state and local tax deductions beyond the new $10,000 limit.

According to the Tax Foundation, states are already planning ways around this. The Tax Foundation mentioned that these proposed ways could include the following:

• Several states are exploring strategies to preserve the full state and local tax deduction for high-income residents, which is capped at $10,000 under the new tax law.
• In California, legislation has been filed to allow residents to make contributions in lieu of taxes, making a voluntary contribution to a new California Excellence Fund and then claiming the full amount as a credit against state income tax liability, since the state and local tax deduction is capped but the charitable deduction is not.
• In New York, Governor Andrew Cuomo is considering creating a new employer-side payroll tax with a commensurate credit against state income tax liability, since employer-side payroll taxes are deductible.
• Case law and IRS regulations generally require charitable intent for a contribution to be deductible, meaning that the individual does not receive a substantial benefit from the contribution. Against this requirement, the sole purpose of the proposed contributions in lieu of taxes proposal is financial gain.
• While the availability of state tax credits does not disallow taking the federal charitable deduction for genuine charitable contributions, any such contribution to a governmental entity must be “solely for public purposes.”
• It is quite possible that the IRS would consider a new employer-side payroll tax with a fully compensatory tax credit to constitute payment of an employee’s income taxes by the employer, which would not only negate the benefit of the plan but could actually increase taxpayer liability.
• Although proponents have contemplated the possibility of graduated-rate payroll taxes to replace graduated-rate income taxes, they have yet to address how such a system would handle individuals with multiple income streams.
• The practical challenges of a payroll tax swap are daunting as well, and the proposal rests on the highly suspect assumption that wages would adjust downward to keep both employer and employee whole.
• Both proposals are interesting, but unlikely to succeed for both legal and practical reasons. If states are genuinely concerned about the effects of their tax codes absent an uncapped state and local tax deduction, they should consider revisiting their tax rates rather than devising increasingly convoluted and legally suspect workarounds.

I will keep you updated as I hear more from the Tax Foundation and other sources. Tax efficiency takes hard work!