IRS Issues Warning to States Enacting Workarounds for State and Local Tax Cap

The recently enacted tax reform law established a new $10,000 cap on the amount of state and local taxes that taxpayers can deduct on their federal taxes.  Previously, taxpayers could deduct the full amounts owed in personal property taxes, and state and local income taxes on their federal tax return. However, taxpayers subject to the Alternative Minimum Tax (AMT) could not deduct these taxes at all.
Since the passage of the bill, a number of states—most prominently New York, New Jersey, and Connecticut—have taken aggressive steps to create “workarounds” for the new $10,000 cap.  While each state’s proposals are different, a common element is to allow taxpayers to make payments to specified state-controlled entities as a charitable contribution (which are still fully deductible) in exchange for a state tax credit against state and local taxes owed.
Last week, the Internal Revenue Service (IRS) issued a notice that they will, “in the near future,” issue guidelines “addressing the federal income tax treatment of certain payments made by taxpayers for which taxpayers receive a credit against their state and local taxes.”  The notice further noted that “despite these state efforts to circumvent the new statutory limitation on state and local tax deductions, taxpayers should be mindful that federal law controls the proper characterization of payments for federal income tax purposes.”
In response, Ways and Means Committee Chairman Kevin Brady applauded the IRS for “responding to these gimmicks,” while the Governor of New Jersey, Phil Murphy, said “I remain committed to fighting the state and local tax deduction tax cap and am confident that the solution signed into law can and should be embraced by the IRS. Anything less is a flat-out admittance that politics rather than policy guides the decisions of the Trump administration.”
Legal analysts remain divided in their opinions about the legality of the workaround.  Some believe that, regardless of any IRS regulations, what some states have proposed will hold up in court.  However, many others dispute this, noting that the workaround will likely be found to be illegal.  If this is the case, taxpayers could on the hook for both their payments to the state government, and a higher than expected federal tax bill.  AGC of America is monitoring the action at the federal level, and will update members with any action taken by the IRS.
For more information, contact Matthew Turkstra at [email protected] or (202) 547-4733.

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