IRS Cracks Down on SALT Deduction ‘Workarounds’
posted Jul 17, 2018 by Paul Oliveira, CPA in the Global Tax Blog
Many taxpayers are voicing concerns over a new limitation under the Tax Cuts and Jobs Act signed into law in late 2017. The TCJA limits the state and local tax (SALT) deduction to $10,000. In recent months, high tax states like New York, New Jersey, Oregon and Connecticut have proposed laws allowing taxpayers to make payments to state-controlled funds in lieu of taxes, thus providing a way to get around the new limited SALT deduction. Is this a viable option for taxpayers?
A bit of background on the SALT deduction
Historically, the ability to deduct state and local taxes has been a valuable tax break for those who itemize deductions on their federal tax returns. In the past, you were able to deduct 100% of state and local income or sales taxes. In addition, homeowners could deduct 100% of their state and local property taxes, too. Essentially, if you itemized deductions in the past, there was no limit on the amount of SALT deductions you could take.
How did the TCJA limit this deduction?
The TCJA limits the itemized deductions for personal SALT amounts to a combined total of only $10,000 ($5,000 for those who are married but filing separately). The limitation applies to state and local 1) income (or, alternatively, sales) taxes, and 2) property taxes.
In addition, personal foreign real property taxes can no longer be deducted. So don’t count on deducting the property taxes on your condo in Canada!
Who will be most adversely affected by this change?
The changes will unfavorably impact individuals who
- Live in high property tax jurisdictions
- Own expensive homes
- Own a primary residence and one or more vacation homes
Are there ways around this?
Connecticut, Oregon, New Jersey, and New York all recently enacted laws to provide alternative federal tax benefits for their residents. In New York, for example, lawmakers have proposed a public fund to which taxpayers can contribute and claim an income tax charitable deduction for doing so. While the TCJA capped SALT deductions at $10,000, it did not cap charitable contribution deductions, so many states are attempting to find ways to take advantage of this.
The IRS’ response
The IRS is cracking down on these “work arounds” that states are using to avoid the limitations. In a notice issued May 23rd, the IRS warned that it intends to issue regulations addressing states’ efforts to minimize impacts of the TCJA, specifically discussing arrangements similar to New York’s SALT workaround.
The IRS warns,“the proposed regulations will make clear that the requirements of the Internal Revenue Code (IRC), informed by substance-over-from principles, govern the federal income tax treatment of such transfers.”
While it may be some time before the IRS issues any proposed regulations on this topic, state and local governments and individuals should proceed with caution regarding these SALT deduction cap workarounds. If it seems too good to be true, it likely is.
Questions? Contact any member of our Tax Services Team.