Treasury Issues Proposed Rule on State and Local Tax Deduction Workaround

On Aug. 23, the Department of Treasury issued a proposed rule that seeks to limit the availability of a tax planning technique that some northeastern states have adopted in the wake of tax reform. The Tax Cuts and Jobs Act – passed in December 2017 – limited the amount of state and local taxes that an individual can deduct to $10,000 per year.  Since then, a number of states – including New York, New Jersey, and Connecticut – have adopted new laws that allow taxpayers in those states to pay their state taxes to a state-sponsored “charity” and receive a partial credit from the state for those taxes paid.
For example, under New York’s proposal, individuals can “donate” a dollar to a state sponsored charity and receive an 85 percent credit against their state tax liability, and 95 percent against their local tax liability.  In theory, under this proposal, because charitable contributions were left uncapped in tax reform, an individual would be able turn their (capped) state tax payments into (uncapped) charitable contributions.
However, the rule proposed by Treasury last week seeks to severely cut back on the utility of these workarounds. Under the proposed rule, a taxpayer would only be able to deduct the uncredited portion of their payment to the state. So, in the New York example above, a taxpayer who makes a $100 contribution to the state-sponsored charity and receives and $85 credit from the state, would only be able to deduct $15 on their federal return.  This proposed rule could also impact additional states that have set up similar arrangements for private school vouchers.
Importantly, this rule does not affect proposals that some states are considering that would provide relief to owners of pass-through businesses, of which AGC is supportive.
For more information, contact Matt Turkstra at [email protected], or (202) 547-4733.

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